• 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
• Discussed at November 2008 IASB Meeting
• Added to the IASB's active agenda November 2008
• Discussed at December 2008 IASB Meeting
• Discussed at March 2009 IASB Meeting
• Discussed at March 2009 IASB-FASB Joint Meeting
• Discussed at April 2009 IASB Meeting
• Discussed at May 2009 IASB Meeting
• Discussed at Special 1 June 2009 IASB Meeting
• Discussed at Special 5 June 2009 IASB Meeting
• Discussed at June 2009 IASB Meeting
• Discussed at July 2009 Joint IASB-FASB Meeting
• For links to discussion at subsequent meetings, go to our sseparate web pages for each of the following components of the IAS 39 replacement project:
  • Financial Instrument Classification and Measurement
  • Impairment and Provisioning
  • Hedge Accounting
• Discussed at October 2009 Joint IASB-FASB Meeting

Timetable

• Click for IASB Project Timetable

September 2004: Financial Instruments Working Group Appointed

In September 2004, the IASB announced the membership of its new working group on financial instruments. The financial instruments working group will help the IASB take a fresh look at the accounting standard IAS 39 Financial Instruments: Recognition and Measurement by examining and questioning the fundamentals of the standard within the context of the IASB's Framework. "The review will therefore focus on improving, simplifying, and ultimately replacing IAS 39 and will examine broader questions of the application and extent of fair value accounting – a topic on which the IASB has not reached any conclusion. Although any major revision of IAS 39 may take several years to complete, the IASB is willing to revise the standard in the short term if any immediate solutions emerge from the working group's discussions", the Board's announcement said.

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.

Discussion at the November 2008 IASB Meeting

(FASB staff joined via videolink)

The session was split in three parts:

• Part 1: Debrief from the first roundtable
• Part 2: Agenda proposal
• Part 3: Issues raised by constituents for urgent consideration

Debrief from the first roundtable

Staff debriefed the Board on the first roundtable on the financial crisis held in London on 14 November 2008 (see IAS Plus Notes). It noted that a general theme at the roundtables was that any next steps of the Boards should lead to convergence between IFRS and US GAAP and that such steps must adhere to due process. It was also highlighted that impairment models under both GAAPs were considered insufficient, and impairment consumed most of the time at the roundtables. Other issues discussed were: accounting for collateralised debt obligations (CDO), fair value option, fair value measurement in illiquid markets.

Agenda proposal

The staff introduced its agenda proposal to add to the IASB's active agenda a project on a comprehensive review of financial instruments accounting. The Board was informed that the proposal had already been discussed with the SAC. The staff noted that SAC supported adding a project to the active agenda, but was split about the expected output.

Board members questioned what the scope of the project would be. Staff responded that the scope would be defined after the project was added to the active agenda. Staff said that more urgent issues could be resolved faster. The staff also informed the Board that the FASB will discuss a similar proposal in the next couple of weeks.

After discussion the Board voted unanimously to approve the staff recommendation to add the project to the active agenda.

Issues raised by constituents for urgent consideration

The staff presented the Board with three Agenda Papers:

• Fair value option
• Accounting for investments in credit-linked instruments
• Impairment requirements for financial instruments

Fair value option

The staff introduced the paper. One Board member noted that a view generally expressed at the roundtables so far was that reclassification out of the fair value option would not improve financial reporting. Another Board member noted that the financial instruments project should consider removing the restrictions that IFRS currently have for invoking the fair value option, thereby converging with US GAAP.

Accounting for investments in credit-linked instruments

There was some confusion about the term credit-linked instruments. One Board member noted that all financial instruments are somewhat linked to credit risk. The staff acknowledged this, but noted that this was a term used in the market for certain instruments. In particular, the perceived different accounting treatment for synthetic Collateralised Debt Obligations (CDOs) under IFRS and US GAAP caused concern amongst constituents. The staff highlighted that this might not be an intended inconsistency and that the US GAAP provisions might have been applied more broadly than intended. The chairman asked the FASB representatives if they will take any actions. FASB staff said they are currently considering possible clarifications to the provisions concerned under US GAAP.

Impairment requirements for financial instruments

The staff discussed current approaches to recognising and measuring impairment under both US GAAP and IFRS. The existence of the different measurement categories aggravated the issue as different impairment models apply to them – in addition to the differences between US GAAP and IFRS in the scope of the various measurement categories. One Board member asked about the conceptual basis for the impairment model under IFRS.

Some Board members highlighted that this issue cannot be fixed quickly and should be considered as part of the comprehensive financial instruments accounting project.

Discussion at the December 2008 IASB Meeting

The staff informed the Board that this was the first of two sessions at the December meeting. At this first session the following topics were discussed:

• Debrief on the public roundtable meetings on the global financial crisis;
• Assessment of embedded derivatives on reclassification; and
• Impairment of financial assets.

Debrief on the public roundtable meetings on the global financial crisis

Staff presented a summary of the three roundtables held in November and December 2008 in London, Norwalk, and Tokyo. While many issues were raised at the round table with impairment being the most discussed, none of the issues were identified as so urgent as to require changes to be applicable for 2008 reporting periods.

Many participants held the view that any further steps should ensure convergence between IFRS and US GAAP and follow due process (possibly accelerated). It was further noted that a comprehensive review of financial instruments accounting was necessary.

The IASB will publish a summary along with a list of participants in due course as requested by one Board member. Staff stressed that the roundtables had been webcast and recordings are publicly available.

The IAS Plus notes from the three roundtables can be found here:

• 14 November 2008 Roundtable in London
• 25 November 2008 Roundtable in the United States
• 3 December 2008 Roundtable in the Tokyo

Assessment of embedded derivatives on reclassification

The staff introduced the topic by noting that some participants at the round tables highlighted the interaction of IFRIC 9 Reassessment of Embedded Derivatives with the recent Reclassification Amendments to IAS 39/IFRS 7. It was suggested to amend IFRS to make clear that, on reclassification, an entity would be required to assess whether an embedded derivative would have to be separately accounted for under IAS 39.

The staff proposed to amend IFRIC 9 to make clear that reclassifications trigger an assessment of the criteria in IAS 39 on embedded derivatives. The Board agreed strongly, highlighting that nothing else had ever been intended. Further, the staff proposed to require retrospective application. The Board agreed.

The staff continued that the exposure draft for this amendment should be open to comment for 30 days only as this did not come as a surprise for constituents given the publicity about the Board's clear position on the issue. The Board agreed. It was further agreed to propose an effective date for annual periods ending on or after 15 December 2008.

This decision triggered some subsequent issues which the staff presented to the Board. The staff noted that it is not clear whether an assessment of bifurcation of embedded derivatives was to be based on the circumstances that existed on the date of reclassification or at the date of inception. The Board agreed with the staff recommendation to require the analysis being based on the circumstances existing at the date of inception. This decision avoided further subsequent issues.

As a final issue the Board decided to require mandatory classification of the entire contract in the fair value through profit or loss category if a separable embedded derivative cannot be fair valued reliably.

The staff noted that the exposure draft is expected to be issued by next week.

Impairment of financial assets

The staff noted that impairment was by far the most discussed issue at the round tables. Two main themes arose in connection with impairment:

• Different impairment approaches
• The meaning of impairment and effect on earnings

Staff said that impairment will be part of the comprehensive review on financial instruments accounting. At this meeting, only specific aspects were discussed:

• Differentiation between credit-related impairment losses and other fair value changes for AFS debt instruments
• Impairment triggers and reversals of impairment regarding AFS equity instruments

Differentiation between credit-related impairment losses and other fair value changes for AFS debt instruments

Participants at the roundtables highlighted the different measurement approaches for impairments of debt instruments in IAS 39 depending on the classification. Particularly, available-for-sale debt instruments' impairment is based on fair value. It was proposed to split up the total impairment charge into an incurred loss piece (that is, what would have been determined as impairment had the instrument been carried at amortised cost and the impairment provisions for amortised cost instruments had been applied) and a remaining balance. The staff noted that participants, however, were divided on the location of this split. Preparers preferred a split in the performance statement with incurred loss charges being recognised in income, while the remaining balance would be recognised in other comprehensive income. Users preferred disclosing the split in the notes with the total charge being recognised in profit or loss.

The staff asked the Board whether such disaggregation would be useful information. Staff further proposed, if the Board agreed, that this is done by requiring additional disclosures.

The Board had a lengthy discussion on this topic. Particular concerns were expressed over any immediate steps that would be impossible to implement for all entities. Further, it was questioned why assets held at fair value through profit or loss were not included. On this issue it was agreed to ask this question in any resulting exposure draft. Others questioned the urgency of this matter that required something to be done within weeks.

The staff presented the Board with possible approaches to a disclosure requirement. The Board discussed at length possible alterations to improve the proposal.

The staff noted that the FASB would discuss a similar proposal later in the day. The chairman noted that the Board should give its counterpart a clear direction on its views. There seemed to be consensus that any disclosure should make clear the resulting amounts if a fair value measurement impairment and an amortised cost impairment were applied. Again, it was questioned whether entities could generate this information retrospectively.

Impairment triggers and reversals of impairment regarding AFS equity instruments

The Board then continued to discuss impairment-related issues. The staff noted that some participants questioned whether the guidance on triggers for impairment of AFS equity instruments could be improved. There seemed to be no sympathy around the table to address the issue. Staff noted that any impairment trigger for equity instruments would be somewhat arbitrary.

The Board also briefly discussed a staff proposal not to address accounting for reversals of impairments of AFS equity instruments as a matter of urgency. It was decided to discussed with the FASB on these issues and bring them back in January.

(At this point FASB staff and members joined by video)

The Board continued its discussions on financial instruments issues.

Impairment disclosures

The first issue discussed were enhanced disclosures on impairments. The FASB staff informed the Board that the FASB has agreed to propose an approach to disclose incurred losses on certain instruments that are fair valued.

Under the FASB proposal disclosure of the following for all investments in debt instruments other than those classified as at fair value through profit or loss would be required:

1. pre-tax profit or loss as though the instruments had been:
   • a. classified as at fair value through profit or loss; and
   • b. accounted for at amortised cost.
2. the following amounts in a way that permits a comparison:
   • a. the carrying amount in the statement of financial position;
   • b. fair value; and
   • c. amortised cost.

This disclosure would have to be provided in tabular format as follows:

The Board discussed certain aspects of the table, the information it was aimed to provide and possible improvements. Some Board members wanted a reconciliation from pro forma to reported profit or loss. The staff responded that they will pick up all proposal by the Board. Some were concerned over the practicability of such a reconciliation and if such a reconciliation was proposed then this question must be asked.

In response to a question by the Board, the FASB staff informed the Board that it planned to issue its exposure draft before Christmas with an effective date of 31 December 2008 with no comparatives to be reported. The Board agreed to adopt this approach.

One Board member asked whether the US proposals to eliminate the guidance on impairment of certain beneficial instruments and transfer it to the general guidance in SFAS 115 would create differences. It was highlighted that, while differences remain, it moves US GAAP closer to IFRS with this 'rationalisation'.

The FASB staff also informed the Board that the plan to issue an exposure draft to clarify the accounting for synthetic CDO instruments, which would also align US GAAP and IFRS.

Fair value option

The staff noted that participants at the roundtables on the global financial crisis asked the Board to review the guidance on the fair value option. Topics of concerns were:

• scope of the FVO;
• eligibility requirements for the FVO; and
• ability to transfer out of the FVO category.

The staff explained that participants wanted to converge the guidance with US GAAP. The staff continued that it had approached constituents that were involved in the development of the revised fair value option. The staff recommended to look at the FVO option as a package, possibly as part of the comprehensive review on financial instruments reporting, as any piecemeal amendments would run the danger of decreasing investors' confidence. The chairman gave an update on the views by the constituents approached, particularly the ECB and the Basel Committee.

The Board agreed.

The staff raised an additional issue by one of the participants that the 'different' definitions of the 'held for trading' category under IFRS and US GAAP would lead to divergence. It was seen as to allow reclassification out of fair value measurement more frequently under US GAAP. The Board was asked whether to provide more guidance. The Board agreed with the staff recommendation not to provide such additional guidance.

Accounting for CDOs

The Board agreed not to address the accounting for embedded derivatives in certain CDOs in the light of the FASB's upcoming proposal which would align the guidance in US GAAP with IFRS.

Discussion at the March 2009 IASB-FASB Joint Meeting

Comprehensive Project

The staff introduced the topic by noting that the ultimate outcome of project was to have a consistent standard under both IFRS and US GAAP. It presented the Board with its recommendation on the project scope: 'To improve the decision usefulness of financial reporting for financial instruments for users.'

One IASB Board member noted this was an objective hard to object to. He continued that the staff has to identify the target staff is aiming at. Another Board member wanted to clarify that all aspects of the framework and its definition of decision usefulness is applied in assessing any proposals. It was further noted that the any improvement would have to result in simplification - some thought this would almost happen automatically.

The IASB chairman reminded participants that both boards made the commitment to develop improved guidance in months, not years. One IASB Board member noted that this meant the starting point was not a blank sheet of paper.

One of the project managers highlighted that the objective was to make the reporting of financial instruments more understandable for users.

Staff then turned to the criteria that would determine the appropriate measurement attribute. There seemed to be consensus around the table that at least two categories for measurement purposes were required: fair value (starting point) and 'something else' (obviously, amortised cost or a current measurement not based on an exit notion).

Board members emphasised that the dividing line between the categories was important and must be understandable.

Three possible approaches for categorisation were identified:

• Characteristics of the instrument, particularly of the cash flows (variability - which would have to be defined)
• Tradeability of the instrument
• Management intent/business model

A majority of board members agreed that certain instruments, particularly derivatives, must continue to be carried at fair value.

The staff then presented its project design:

• Objectives of project (discussed at this meeting)
• Alternative measurement bases
• Allocation of financial instruments into measurement categories
• Impairment model (if amortised cost is identified as a measurement basis)
• Reclassifications and a fair value option
• Hedge accounting (decision to address in this project or potentially as a separate project)
• Presentation, disclosures, effective date and transition

One IASB Board member remarked that the selection of any measurement attribute should also be assessed based on the presentation of the changes in value. He emphasised that some topics in the list are interrelated. A FASB Board member asked whether the staff intended to propose any form recognition of changes in values directly in other comprehensive income. The staff responded that it had no intentions at this point.

The IASB chairman then summarised the session:

• The goal was to have two measurement attributes, but to consider a third one
• Define this potential third measurement candidate appropriately
• Define one impairment model
• Derivatives should be measured at fair value (the chairman took a vote on this and 13 members of both boards agreed)
• Analyse and assess the potential dividing lines for allocating instruments to the measurement categories (see above)

Impairment - Dynamic Loan Loss Provisioning

The staff informed the Board that the purpose of this session was to have a general discussion on the topic of loan loss accounting and whether this topic should constitute a separate work stream in the financial instruments project.

The staff noted that to understand the models proposed for possibly replacing the IAS 39 incurred loss model, further meetings with constituents were necessary, particularly with the Spanish Central Bank as their model is considered by some constituents as a possible starting point for improving the guidance on loan loss provisioning. It was also emphasised that 'through the cycle' provisioning would require recognising impairments above an expected loss due to the duration of an economic cycle (10-15 years) compared to an average loan maturity.

The staff further noted that the term 'dynamic provision' is not well defined and different people think of different models when talking about dynamic provisioning.

Board members asked why the expected loss on day one would not be factored into the transaction price. Staff confirmed that theoretically all loss expected on the date of transaction should be factored into the transaction price. The staff said that if impairments are higher, the unwinding of them lead to a higher effective interest rate in the future, which under certain scenarios could lead to a pro-cyclical effect. It was noted that under the current IAS 39 model the effective interest rate is kept constant and the cash flows are adjusted.

Board members had some discussions on what impairment represents, technical considerations, and whether an expected loss model is closer to fair value. None of those discussions were conclusive.

In the end the boards decided that the issue of impairment was important enough to justify it being established as a separate work stream in the financial instruments project.

Discussion at the April 2009 IASB Meeting

Financial Instruments – FASB amendments on fair value measurement and other-than-temporary impairments

The Board received a summary of responses to their request for views on FSP FAS 115-2 and FAS 124-2 Recognition and Presentation of Other-Than-Temporary Impairments.

The board received over 60 letters giving views on the FSP which were primarily from financial institutions, prudential regulators and national standard setters.

No respondents recommended full adoption of the FSP. Responses were broadly split into those that recommended limited amendments to the impairment rules of IAS 39 and those that recommended no immediate change but instead for the staff to focus on the broader IAS 39 project addressing methods of measurement and characteristics for categorising financial instruments.

Those that recommended limited amendments had a variety of suggestions, with banking entities focussing on attempting to achieve a level playing field with US GAAP and address the issue of the perceived overstatement of losses under the current model.

Board members recalled that at past round table discussions and in various comment letters received (including those to this FSP and the January ED on Investments in Debt Instruments) the general feedback has been an opposition to short term piecemeal changes to IAS 39 without due process.

It was noted that if amendments to the impairment rules was dealt with as a separate project it would put pressure on time and resources dedicated to the broader IAS 39 project. Further, if sufficient time is to be given for deliberation and due process any final amendment to the impairment rules would not be issued long before the final amendments arising from the broader IAS 39 project. Board members highlighted that if the impairment rules were first changed as part of a separate project then changed again (or removed) as part of the broader IAS 39 project this would lead to two changes to the standard in a short space of time increasing the cost of implementation for preparers.

As a result the Board unanimously decided there should be no piecemeal change to the impairment rules of IAS 39 but instead a focus on the broader IAS 39 project which should consider the suggestions received in the request for views on the FSP.

Financial Instruments: Recognition and Measurement – Comprehensive reconsideration of IAS 39

The Board gave a brief summary of its timetable on the IAS 39 project to develop a comprehensive standard for the recognition and measurement of financial instruments. This timetable aims for the Board to begin to make tentative decisions on the measurement methods for financial instruments and the potential characteristics for categorising financial instruments in time for the joint FASB and IASB meeting in July.

This session was the first of series to ensure Board members comprehensively understood the different possible measurement methods available and the perceived advantages and disadvantages of each in order to make informed decisions on which method to choose at a later stage. No decisions on which method to adopt were made at this meeting.

This session discussed the first of three different measurement methods: amortised cost (the other two being discounted cash flows and fair value which will be discussed in the next two months).

The Board discussion focussed on the three different impairment models: incurred loss, expected loss and fair value based. Board members raised the point that when it comes to choosing which model to use, they will need to understand the objective of measuring impairment and the principle behind it such that criteria can be used to assess each model.

Board members debated how an expected loss model would work in practice which highlighted differences in understanding of the model. Some board members expected it to equate to a fair value model, based on the discount rate being recalculated to reflect market rates. Questions were raised over whether the expected loss model was applied on a portfolio basis or an individual basis. There were different expectations about whether the expected loss model resulted in a smoothing in impairment losses.

Board members requested that the concepts in FSP FAS 115-2 and FAS 124-2 be appropriately considered in the fair value based model.

As a result of these discussions further detail would be provided to the Board on the expected loss model and the fair value based model at the next Board meeting.

IASB Decisions on FASB Staff Positions

The IASB reviewed the two recent FASB Staff Positions (FSPs) on fair value and impairment of financial assets and has reached the following conclusions:

• FSP FAS 157-4, which provides guidance on determining fair value when market activity has decreased. The IASB has agreed that the guidance in FSP FAS 157-4 is broadly consistent with the principles of fair value in IFRSs and the recommendations of the IASB's Expert Advisory Panel. The IASB plans to include relevant guidance from the FSP in the IASB's exposure draft on Fair Value measurement, which will be published in May.
• FSP FAS 115-2 and FAS 124-2, which addresses other-than-temporary impairments for debt securities. The IASB has decided not to propose adopting the conclusions in this FSP. This FSP applies to debt securities and shifts the focus for assessing impairment from an entity's intent to hold until recovery to its intent to sell.

  FSP FAS 115-2 and FAS 124-2 requires: An entity must assess whether (a) it intends to sell the debt security or (b) it is more likely than not that the entity will be required to sell the debt security before its anticipated recovery (for example, to meet working capital needs). If it does intend to sell (or it cannot assert that it is more likely than not that it will not have to sell the securities before recovery), the entity will write the asset down to fair value through earnings. If an entity does not intend to sell a debt security (available-for-sale or held-to-maturity), but it is probable that the entity will not collect all amounts due according to the debt's contractual terms, the entity will bifurcate the impairment amount: The impairment due to credit, measured as the difference between amortized cost and the present value of expected cash flows discounted at the security's effective rate, would be recognised in earnings. The remaining amount of the impairment (noncredit portion) would be recognised in other comprehensive income (separately from other unrealised gains and losses on available-for-sale securities). The noncredit portion for held-to-maturity securities recorded in other comprehensive income should be amortised prospectively (with the offsetting amount increasing the value of the asset) over the remaining life of the security.

  In deciding not to adopt FSP FAS 115-2 and FAS 124-2, the IASB said that, instead, it will take up the broad issue of impairment as part of its comprehensive review of IAS 39. The IASB believes that an immediate response to the recent FSP on impairment is unnecessary. The IASB also announced a timetable for the IAS 39 review, which calls for issuance of an exposure draft of a proposed replacement for IAS 39 by October 2009.

• IASB Press Release (PDF 112k).
• More Information about the FSPs

Discussion at the Special IASB Meeting on 5 May 2009

The staff introduced the session by reminding the Board that at the March 2009 Joint Meeting the boards decided tentatively to consider three potential measurement models:

• (a) fair value (defined as exit price);
• (b) another remeasurement method based on discounted cash flows (DCF remeasurement method); and
• (c) amortised cost (including impairment).

At the April 2009 Meeting the IASB discussed amortised cost and possible impairment approaches. This discussion will continue at the May IASB meeting.

The purpose of the special meeting was a public education session on the DCF remeasurement method. It is an opportunity for the Board to identify questions about the method and request additional information they may require to understand the model.

The staff noted that the FASB will be discussing the method tomorrow, and the FASB will be provided with feedback from this meeting. Further discussions on the model will be held at future IASB meetings.

The IASB staff's agenda paper for this meeting was accompanied by a Paper Prepared by the Staff of the FASB describing the DCF remeasurement method – referred to in the FASB staff paper as the 'Current Value Measurement Method'. The FASB staff paper states:

The current value measurement method is based on the notion of calculating a value for a financial asset or financial liability based on the present value of expected future cash flows of the financial asset or financial liability. The value calculated by this method is not based on an exchange price but instead is based on the cash flows in the instrument that an entity would realize through the collection or payment of the cash flows with the counterparty to the instrument. The purpose of this method is to provide an alternative to fair value for certain instruments in certain situations and not to replace fair value in all situations.

The staff said that this model is not intended to be a replacement of the fair value method. The chairman then asked each Board member to provide input in turn.

A number of Board members expressed concern as to how the risk premium was calculated in the model. They were unclear as to how this calculation was done. A number of Board members also asked the staff to provide clarification as to what additional guidance would be required to ensure that the model presented could be applied consistently to enable comparability.

In relation to the Current Value Measurement Method in the staff paper, one Board member described this as 'arithmetic magic'. Many of the Board members expressed concerns relating to this method. A number of other Board members had concerns around how method 2 would be operationalised. One Board member queried why this Method includes three scenarios when the method works fine on the total. The same Board member queried how it was possible to obtain a cash flow greater than $100,000.

Also in relation to the Current Value Measurement Method, many Board members queried whether this was an entity specific measure or market based. A number of Board members also asked the staff to clarify how or why the two methods get to different answers. Some Board members noted that they thought that the objective was that both methods would get to the same answer. One Board member queried whether from a practical point of view whether the methods could actually be applied in practice.

Some Board members also queried when the model would actually be applied – all the time or only in extenuating circumstances? Other Board members queried whether the model would only be applied for Level 3 estimations. The Chairman noted that understanding when the model would be applied was critical. Further, he noted that it is important to understand where the model fits in – is it a third method or a replacement for amortised cost?

The staff thanked the Board for their feedback and will provide the questions and comments to the FASB staff. One Board member concluded by noting that the comments the Board members have raised will be difficult to answer.

Discussion at the May 2009 IASB Meeting

Expected Loss impairment method

Amortised cost – an expected cash flow approach

The staff introduced the session with a brief overview of the key features of an expected cash flow approach to recognising impairment for assets measured at amortised cost. In particular they reminded Board members that this approach would remove the requirement to identify a trigger event before recognising credit losses.

Board members discussed the worked examples provided by the staff in their agenda paper. Initial discussions concentrated on Example 3 which illustrates a scenario where the amortised cost is calculated to be higher than original cost. Some Board members were uncomfortable with this if the objective of the expected loss model is to measure impairment, as a carrying value exceeding cost would seem counter-intuitive (ie indicating negative impairment). Other Board members were happy with the example as they believed it was a consequence of effective interest rate methodology and simply represented the present value of future interest and principal cash flows.

Discussion moved on to how the expected cash flows used to calculate the effective interest rate would be defined. Board members requested clarification on whether the expected cash flows would be the entity's own expectation of cash flows or the entity's estimate of a market participant's expectation of cash flows. Board members also requested further clarity on which risks should be included in the expected cash flow and which risks should be included in the effective interest rate.

One Board member questioned whether the expected loss model actually reduced complexity and the burden on preparers because of the need to reassess expected cash flows on a continuous basis even where there have been no impairment triggers. Other Board members felt that the removal of impairment triggers in the current incurred loss model would reduce complexity overall.

The staff informed the Board that they are in the early stages of exploring with some banks the systems impact of an expected loss approach.

Board members requested the staff to give more detail on how collective and individual impairment would work under an expected cash flow approach. The staff informed the Board that the interaction between individual and collective impairment would be another topic covered in their discussion with banks to gain an understanding of the practical impacts.

Some Board members expressed concern that an expected loss model may obscure the reporting of credit losses as in cases where expected losses are correctly estimated at inception, no bad debts would subsequently be recorded.

Amortised cost – objective of an impairment test and implications for financial assets

The staff presented their paper setting out the differing complexities for measuring impairment of financial assets versus non-financial assets.

It was explained that the general approach for measuring impairment for non-financial assets is based on current values due to the nature of such instruments. However, for financial assets, alternatives are available as cash flows associated with such instruments are contractual.

The Board expressed an understanding of the different characteristics of financial and non-financial assets and the consequential different impairment approaches available.

Fair value impairment Method

The staff summarised from their paper the key points to consider in relation to a fair value based impairment model. They then put forward to the Board a version of such a model, not recommended by the staff but for discussion purposes only. Under this version an impairment is recognised if the fair value of the instrument is below its amortised cost. As long as fair value is below amortised cost the financial asset is measured at fair value. Once fair value is equal to or above amortised cost the asset is once again measured at amortised cost.

One Board member raised the point that such an approach would require the simultaneous tacking of amortised cost and fair value. The staff highlighted that this was currently required for certain impaired debt instruments classified as available for sale.

Comparison between impairment approaches

With the objective of aiding Board members decide between the three different impairment approaches (incurred loss approach, expected cash flow approach and fair value based approach) the staff presented their paper comparing each approach.

One Board member requested that the cost to stakeholders of each model not only be shown as a cost of implementation but instead be split between cost of implementation and on-going cost. It was agreed that this would allow a better comparison to the existing model which has no incremental implementation cost.

Board members enquired whether the costs of implementation of the expected loss model would be significant for banks given their existing internal systems used to produce Basel 2 data and fair value calculations. The staff explained that this was being explored in discussions with banks over the next month.

Classification

The Board discussed circumstances in which financial instruments could be measured on a basis other than fair value.

The staff presented their paper to begin the discussion about possible classification criteria for financial instruments which would subsequently drive their measurement basis.

The three possible criteria put forward were:

1. the characteristics of the instrument
2. the business model of the entity; and
3. the intent and or ability to trade the instrument.

Board members debated each criterion. Some Board members objected to a criterion based on management intent in part due to the potential for this intent to change over time based on market conditions. However, some Board members felt that management intent was relevant to predict the cash flows that would be realised from any financial instrument. These Board members also suggested that changes in intent could be highlighted to users through appropriate disclosure.

Board members considered the notion of distinguishing between instruments based on the predictability of their cash flows. This would distinguish between instruments with predictable cash flows and instruments with volatile cash flows. Some Board members questioned whether such criteria could apply to derivatives. One Board member highlighted that the cash flows on forward foreign currency contracts have a high degree of predictability and question whether this could result in it being grouped with vanilla instruments with predictable cash flows (such as loans) and potentially measured on a basis other than fair value. Other Board members suggested a distinction would need to be drawn between leveraged and unleveraged instruments which would result in derivatives being categorised differently. Some Board members stated that they did not believe the measurement basis for derivatives was up for debate and would remain at fair value.

Board members questioned whether the criteria for characterising instruments would be done only at inception or on a continuous basis.

One Board member felt strongly that instruments should not be characterised solely on the predictability of its cash flows. He believed a distinction should be drawn based on whether the instrument could be traded. Some board members felt that most instruments could be traded which would result in no clear distinction. Other Board members noted that the ability to trade an instrument will not necessarily mean that an entity would realise the cash flows of that instrument by selling it but instead could realise the cash flows by holding the instrument to maturity. In such a case characterising the instrument as traded would conflict with management intent.

Some felt there was congruence in practice between the characteristics of an instrument and the way in which the cash flows of that instrument was realised. The implication was that plain vanilla instruments tended to be realised through their contractual cash flows whilst more complex instruments tended to be realised by sale. As a consequence the focus on management intent was overdone.

One Board member suggested that an amortised cost measurement basis should be used for instruments with predictable contractual cash flows. Another Board member objected to this on the basis that it would introduce measurement complexities for instruments that met this criterion but were traded in an active market from which a single measure of fair value could easily be obtained, for example an investment in a government bond.

A number of Board members indicated their preference for fair value measurement for equity instruments. This was the case even where equities were held for strategic purposes on a long term basis. Questions were raised as to whether this would be fair value via profit or loss or fair value via other comprehensive income.

Starting point for a classification approach

The discussion moved on to considering a possible starting point to determine a classification approach between fair value and amortised cost. Three approaches were put forward.

• Approach one – based on current IAS 39 amortised cost categories, that is, whether the instrument has fixed and determinable payments
• Approach two – based on an approach used in the forthcoming IFRS for Small and Medium-sized Entities, that is, a distinction between basic and non-basic financial instruments
• Approach three – based on whether the asset was originated by the entity.

On a straw poll a majority of Board members broadly supported approach two, however, some Board members felt that additional modifications would be needed to this approach, for example in relation to excluding actively traded instruments from amortised cost measurement. In the absence of modifications those board members would support approach three. Therefore, a majority of Board members would allow certain highly liquid instruments that were deemed basic to be accounted for at amortised cost.

Board members were asked whether they would support the removal of tainting rules for assets classified as amortised cost based on an entity's intention to hold the instrument to maturity, in support for additional disclosures if the asset was subsequently sold. Board members were generally in favour of this.

One Board member put forward the idea that a distinction could be drawn between basic instruments under approach two based on whether their fair values could be determined on a level one, two or three basis and allowing at least level 3 instruments not to be fair valued. Some board members felt that level two instruments should also be excluded from fair value measurement if they were considered basic under approach two.

When asked, no board members objected to the notion of a fair value option for instruments that were traded. Therefore, the key consideration for the Board was over whether fair value should be mandatory for certain instruments, and if so, which instruments.

The Chairman moved discussion on to the recognition of gains and losses for instruments measured at fair value. Board members were asked whether they would consider an approach where fair value gains and losses would either be (1) recognised in profit or loss or (2) recognised in other comprehensive income and never recycled to profit or loss. A majority of the Board agreed they would consider such a treatment.

The Chairman summarised the debate as follows:

• There was support for simplifying the categorisation of financial instruments into two buckets: fair value and amortised cost. The majority supported an approach that builds on the approach used in the forthcoming IFRS for Small and Medium-sized Entities.
• There was support for a fair value option to permit fair value for an asset that would meet otherwise meet the requirements of amortised cost.
• Within the fair value category, changes in the value of some instruments could be recognised in other comprehensive income.
• No reclassifications between categories would be permitted.

Dividing the Financial Instrument project into parts

The Chairman then suggested that, given that it was possible that the Board had a workable model for the classification of financial instruments, many impairment issues existing in IAS 39 would be removed. It was suggested that, if the staff concentrated on developing this classification model, it would be possible to issue an exposure draft by July 2009 with a 2 to 2.5 month comment period. The expectation would be an IFRS would be issued by the end of 2009.

In addition, the Board would issue a Request for Views on the impairment issues remaining given the classification model in the exposure draft. The expectation is to issue this concurrently with the classification ED. The Board would use that input to develop an exposure draft that would be issued in the final quarter 2009. Also, proposals on hedge accounting would also be issued in the final quarter 2009.

Board members expressed concerns about transition and implementation issues. The Chairman stated that these would be addressed at their special meeting on 5th June.

Discussion at the Special IASB Meeting 1 June 2009

The staff opened the meeting by summarising the tentative decisions reached by the Board in last month's meetings. These included:

• A working premise of two measurement bases of fair value and amortised cost.
• A starting point for classification based on the approach adopted by the forthcoming IFRS for SMEs.
• Retention of a fair value option in some form (although not intended to be discussed at this meeting).
• Not permitting any reclassifications.
• Removal of tainting rules and replacement with additional disclosure requirements.

Classification - principles that govern characteristics of financial instruments

The staff then presented their principles based, two-step approach to classifying financial instruments that entails first characterising financial instruments that qualify for amortised cost accounting and then applying a business model overlay to override amortised cost accounting with mandatory fair value accounting. This approach is based on the IFRS for SMEs as a starting point with changes to derive a principle for classification based on cash flow variability of a financial instrument.

Some Board members raised concerns that principles developed could not be operational. They said that characterising instruments based on cash flow variability added complexity and ignored fair value variability. One Board member particularly objected to the consequence of applying the two-step approach to a loan asset with a written cap, which would result in amortised cost accounting for the instrument as a whole. The Board member preferred an approach that considered all terms of the instrument (not just cash flow variability), which in this case should result in the instrument to be accounted for at fair value through profit or loss in its entirety. Not to do so would ignore the instrument's fair value variability introduced by the written option. Another Board member, who supported the staff's proposal, suggested such fair value variability existed for 'vanilla' fixed-rate instruments and hence should not be of concern in itself. However, the concern was more based on the asymmetrical fair value variability, as opposed to just variability.

Some Board members supported the staff's approach and considered a principle based on cash flow variability favourable over an approach that started with a list of instruments for each classification.

When asked by the Chairman, a majority of Board members agreed with the general thrust of the staff's proposal of amortised cost for certain 'vanilla lending instruments' and fair value for all other instruments.

Classification - implications of the business model

The Chairman introduced the next staff paper dealing with the business model overlay. He drew the Board's attention to the staff recommendation that the business model overlay require mandatory fair value measurement for those instruments that are managed and their performance assessed on a fair value basis (which is intended to include all financial instruments held for trading). The staff explained that this would broaden the fair value measurement requirement.

The Board discussed whether a very liquid financial asset (such as a traded treasury bond) available as a liquidity reserve should ever qualify for measurement at amortised cost. Most Board members felt that it should not.

Some Board members felt uncomfortable with the staff's recommendation that could result in an entity recording, at the same time, some liquid treasury bonds at fair value (if held for trading) and some at amortised cost (if held for non-trading purposes and not managed or assessed on a fair value basis).

Some Board members approved of the business model overlay as they felt it was based on fact (the business model) as opposed to management intention or any chosen designation.

One Board member disagreed with the notion that classification based on a business model would result in decision useful information.

The Chairman summarised the Board's views as supportive of a version of an overlay that would require fair value accounting for certain instruments, which would at least include instruments held for trading. He proposed the staff consider the Board's comments and come back with a refined approach.

Classification - Implication for embedded derivatives

The staff presented three alternatives to deal with embedded derivatives in the revised standard as follows:

• Alternative one: Maintain the existing requirements
• Alternative two: Eliminate the concept of embedded derivative accounting
• Alternative three: Change the bifurcation criteria

The Chairman explained he instinctively would support alternative two. The staff's view was that this would be a significant change and would be difficult to implement in the time frame given that the rules for assessing derivatives embedded in non-financial instruments would have to be retained. The staff felt that changes to the rules on embedded derivatives would require wider consultation.

One Board member disagreed with the staff's recommendation for alternative one. He felt that a classification principle could be designed to accommodate embedded derivatives in financial instruments which would result in the entire instrument being classified as fair value through profit or loss.

Another Board member felt uncomfortable dealing with embedded derivatives at a later stage as this would result in a piecemeal approach to overhauling IAS 39.

The staff agreed to reconsider its views based on the Board's comments.

Equity Instruments: OCI method

The staff reminded the Board of its tentative decision in the May meetings to consider a fair value measurement basis where gains and losses were recorded in other comprehensive income with no subsequent recycling.

The staff's recommendation put forward was to allow an entity, on initial recognition, a free choice to designate equity investments at fair value with gains and losses recorded in other comprehensive income. The designation would be irrevocable.

The Board was divided, with some not supporting the free choice and others happy that the irrevocable designation and enhanced disclosure requirements would impose sufficient discipline. Those that opposed the free choice wanted the designation to be restricted to specific situations where the benefit of holding the investment was to fulfil a wider business objective and not for income or capital gain purposes. The staff explained they set out with the intention to limit the designation but then found it too difficult to set definitive criteria.

Some Board members were uncomfortable with the possibility that under the staff's recommendation different purchases of the same equity investment could be given different classifications (that is some at fair value through profit or loss and some at fair value through other comprehensive income).

Transitional provisions and equity instruments cost exemption

The meeting continued past the scheduled time and four Board members left the meeting. The Chairman proposed that the meeting continue to discuss the remaining papers with no decisions to be made until the next meeting.

The staff put forward their recommendation for retrospective application of the proposed changes, in accordance with IAS 8, along with additional disclosure. The basis for this recommendation was to enhance comparability with the comparative period and avoid changes in measurement basis part-way through a reporting period (which could be the case if prospective application was permitted from, say, November 2009).

Some Board members were concerned that preparers may use the benefit of hindsight to determine fair values. Others felt this would not arise as fair values would have already been reported.

The staff agreed with the Board's concern that computations of amortised cost could be costly and time consuming.

As the meeting drew to a close the staff's recommendation of removing the cost exemption for certain unquoted equity investments was briefly tabled to gauge from the remaining Board members whether there were any objections. None were raised.

Discussion at the Special IASB Meeting 5 June 2009

The staff began the meeting by summarising the current classification model that is being pursued. In summary, financial instruments will be measured at fair value or amortised cost. Amortised cost will apply to debt instrument assets that are not held for trading that are deemed 'basic' and are managed on a contracted yield basis (the detailed criteria to be determined at the next Board meeting). Equity instrument assets not held for trading that meet a specified principle (to be determined at next meeting) will be fair valued through other comprehensive income (OCI) with no recycling and no impairment assessment. Other financial instruments will be fair valued through profit or loss. It is expected there will be a fair value option in the case of an accounting mismatch.

The following areas will also be discussed at the next meeting (week of 15-19 June 2009):

• Embedded derivatives – whether to retain the existing guidance for financial host contracts or to remove the guidance and instead look to the amortised cost definition to identify characteristics of those debt instruments that will be at amortised cost and those that will be at fair value through profit or loss.
• How the classification model will deal with debt instruments that have a concentration of credit risk.
• Use of the fair value option.
• Use of other comprehensive income (OCI) to record fair value gains and losses for equity instruments. The staff indicated that if a principle was developed for the use of OCI to record gains and losses for certain equity investments, there should be a discussion of whether reclassification may be required. This is because the principle allowing the OCI treatment may become applicable or cease to be applicable to a given equity investment subsequent to initial classification.

Before proceeding, the Chairman asked each Board member whether they broadly agreed with the direction in which the project was heading with regard to classification. All members except one agreed.

Transitional provisions

The staff summarised the view with which Board members present at the meeting on 1 June 2009 broadly agreed, basically a retrospective application approach subject to exceptions that would be addressed in more detail at the regular June Board meeting.

The Chairman requested views from the Board members who were not present at the last meeting when transitional provisions were discussed.

One Board member accepted that IAS 8 establishes a general principle for retrospective application which he agreed with. However, he felt that the appropriateness of that principle in this scenario depended on the robustness of the chosen classification model. For example, a loose classification model allowing an entity to effectively choose a measurement basis for each financial instrument may not be suitable for retrospective application because of the ability to be selective over the reversal of past recognised losses.

One Board member noted that entities selecting amortised cost accounting over fair value accounting to reverse past recognised losses would also restrict themselves from recognising future fair value gains.

Another Board member raised concern that they could not comment on the appropriateness of retrospective application without knowing the impact of the chosen classification model.

The staff felt that one of the main impacts of a revised classification model would likely be that some debt instruments currently classified as available for sale (AFS) would instead be measured at amortised cost (because of the removal of the tainting rules). Other impacts would depend on decisions made at the June Board meeting, such as the treatment of hybrid instruments.

The Chairman reiterated that the objective of the current meeting was to establish whether any Board members opposed to the staff pursuing further retrospective application. When put to the vote all except one agreed that the staff should proceed with preparing a more detailed paper on retrospective application for the main June Board meeting.

Board members requested that any staff paper on the matter include a cost benefit analysis of retrospective application and include examples of application. The staff stated that there were a number of areas to address with respect to retrospective application, including hedge accounting, impairment, and previous application of the fair value option/reclassifications amendment, which would be covered in their paper.

Equity investments: cost exemption

The staff began by summarising that the Board members who discussed the equity investment cost exemption at the last meeting broadly agreed with the proposal to remove it. The Chairman then asked each Board member who was not present at that meeting to provide their view. Of all the Board members, two did not agree with the proposal to remove this exemption. The reason given was the impact it would have on non-financial institutions holding significant unquoted equity investments. One Board member felt that fair values calculated would be unreliable and difficult to audit.

Another Board member suggested whether the criteria for fair value through OCI should be different for unquoted equities.

Timetable

The staff provided a summary of upcoming documents and meetings:

• The staff will be presenting educational webcasts next week to provide information on the project to date.
• An invitation to comment staff paper is due to be issued in June 2009 regarding the incorporation of credit risk in liability measurement.
• The classification and measurement exposure draft is planned to be issued in July 2009, with a minimum of a two month comment period. Comments would then be deliberated with the expectation of a final standard issued by December 2009. The staff confirmed that there was no intention to a make any final standard on classification mandatory for December 2009 year end financial statements, that is, it would be available for early adoption.
• A request for views would be issued on impairment in July 2009 which would ask specific questions on the implementation challenges of different models. Comments received would provide input into Board discussions in September with an exposure draft planned for October 2009. At the June Board meeting, BNP Paribas will present to the Board the challenges of amortised cost accounting based on an expected loss model. Bank of Spain would also present their dynamic provisioning model.
• An exposure draft dealing with hedge accounting is planned for issue in December 2009.

Discussion at the Regular June 2009 Board Meeting

Monday 15 June 2009 – Educational Session: Operational Challenges of an Expected Loss Provisioning Model

Four representatives from BNP Paribas appeared before the IASB 'as fellow thinkers' to discuss the operational challenges of the expected loss provisioning model. They based their assessment on the expected loss model put forward by the IASB staff in May 2009, and in particular Agenda Paper 5D. The BNP team attempted to illustrate how such a provisioning model might be applied in their circumstances.

A key question for financial institutions would be whether the expected loss method reduced pro-cyclicality in financial reporting or whether it would be counter-cyclical. Their initial reaction was that the expected loss model was less pro-cyclical than the incurred loss model, but was not counter-cyclical.

BNP Paribas had estimated that the cost of implementing an expected loss approach to loan loss provisioning would be significant and would extend for three years: one year for development of systems and two years for deployment. Variable rate assets were problematic, and the systems consequences of such instruments still needed to be explored. Speaking personally, one of the presenters thought that banks would be prepared to incur these significant costs if the approach reduced pro-cyclicality. However, the banks would probably not want to incur those costs if they also had to deal with an additional regulatory loss provision.

One problem with using the Basel II data is that it is very crude: the cut is short-term versus long-term, whereas the expected loss model would require more granularity in the data captured by the systems. Some operational efficiency could be achieved by being able to monitor portfolios of similar loans rather than individual loans, but that would also involve systems challenges, given the sheer volume of different types and maturities of loans involved. Again, this still needed to be explored.

Board members probed various aspects of the model with the presenters and clarified certain points. It was clear from the presenters that it would simplify their lives as preparers if there was a high degree of consistency between the data needed for loan loss provisioning for financial reporting and prudential regulatory purposes. However, it was also obvious that some Board members were still uncomfortable with some of the smoothing consequences of the expected loss model.

Both sides expressed a desire to continue to work collaboratively on exploring the expected loss model. The IASB staff reminded constituents that a Request for Views document is expected to be released later in June or very early in July 2009 and would explore the expected loss model in an attempt to gauge its feasibility.

Tuesday 16 June 2009 – Discussion of Comprehensive Project to Replace IAS 39

The staff opened the meeting by laying out the agenda which would consist of board discussion and vote on the seven items below relating to the proposed new classification structure and transitional provisions.

Embedded derivative accounting

The staff summarised their paper on the subject which contained three alternatives for the board to consider. They were as follows:

• Alternative 1A: Use the embedded derivative assessment as a filter for classification. Under this alternative embedded derivative assessment and any bifurcations would take place as under existing requirements in IAS 39, and in a second step the bifurcated derivatives, host contracts and hybrid contracts which had not been bifurcated would be classified using the new criteria.

• Alternative 1B: Use the embedded derivative assessment as currently exists in IAS 39 as the classification assessment itself. Under this approach embedded derivatives which are separated would be automatically classified at fair value, and the host at amortised cost. If no bifurcation takes place the instrument automatically qualifies for amortised cost in its entirety.

• Alternative 2: Eliminate the concept of embedded derivatives altogether. Under this approach a hybrid instrument would be classified according to the new criteria in its entirety. Thus a derivative embedded in a debt instrument, for example a commodity price indexation, could result in a cashflow stream which disqualified the instrument from being classified at amortised cost under the new criteria and the entire instrument would be classified at fair value. However features such as interest rate caps, floors or collars which would result in an instrument's yield being switched from fixed to floating rate or vice versa would not preclude an instrument from being classified at amortised cost. This is because, since both fixed rate instruments and floating rate instruments would qualify for amortised cost, the staff viewed an instrument which combined the two elements should also qualify for amortised cost accounting in the absence of any other features. Given that a potential weakness of this approach is that a relatively insignificant embedded feature could result in an instrument being classified at fair value in its entirety, the staff recommended the introduction of a materiality overlay to assess the significance of such features on the variability of cash flows from the instrument as a whole for classification purposes.

Two board members voiced strong support for alternative 2 as the cleanest and simplest approach, and therefore the approach most in line with the objective of reducing complexity. It was pointed out that there would be no interaction between the embedded derivative provisions laid out here and the proposed treatment of the fair value option since it was proposed that the latter would only be retained for elimination of accounting mismatches. One board member believed the materiality overlay suggested as part of alternative 2 should not be retained as materiality should be a consideration in interpreting all standards. Three other board members voiced support for this opinion.

In response to concerns that alternative 2 would lead to change on a large scale, one board member commented that there would be sufficient lead time if an adoption date of 1 January 2011 was adopted. One board member commented that there could be potential for financial engineering given that some instruments containing embedded derivatives would be measured at amortised cost. Another board member responded to this concern by stating that it would be doubtful that instruments containing complex or multiple embedded derivatives would qualify for amortised cost treatment.

11 board members voted in favour of alternative 2. A majority voted against inclusion of the materiality overlay, with 2 votes in favour.

Concentrations of credit risk

The staff summarised their recommendations in this area. The issue relates to concentrations of credit risk at the individual financial instrument level due to subordination, that is, the existence of a priority of payments structure for different instruments issued by the same debtor. The implication of this is that senior and secured creditors are not usually leveraged and thus would meet the criterion of 'having only basic loan features'. However junior instruments held within a waterfall structure would be contractually leveraged, providing credit protection for more senior tranches. Instruments which provide protection for other tranches would not be basic lending transactions and so would be required to be measured at fair value. However subordinated debt instruments within a general creditor structure which is not a waterfall would not be contractually leveraged since they reflect the default ranking established under commercial law. As such they would satisfy the criterion of having only basic loan features.

There was some discussion as to whether this would contradict the tentative agreement that basic loan features would be defined as having only principal and interest cashflows, since all tranches including junior instruments issued would satisfy this criterion. However the board agreed that the element of contractual leverage and consequent differential in credit risk between senior and junior debt adds another factor to cashflow profile and so there is no inconsistency.

The board agreed (13 votes in favour) that application guidance should be included on concentration of credit risk, and also concurred with the staff position differentiating waterfall structures and creditor ranking as a basis.

Fair value option

The staff presented their position that the fair value option should be restricted to the eligibility criterion that the designation eliminates or significantly reduces an accounting mismatch. As such two of the criteria currently permissible under IAS 39, namely:

• Where a group of financial assets or liabilities is managed and its performance evaluated on a fair value basis, and
• Where a hybrid contract contains an embedded derivative, unless that embedded derivative does not significantly affect the cash flows or is closely related to the hybrid contract

One board member, agreeing with the staff position, noted that it should be made clear within the literature that the two criteria which would be dropped were already dealt with elsewhere by the new measurement criteria.

The board voted in favour of the staff position.

OCI method for equity instruments

The staff referred to the board's tentative position that fair value changes for certain equity instruments would be allowed to be presented through other comprehensive income (OCI) but that and subsequent transfers to profit or loss, including on disposal, would be prohibited. The staff presented two possible approaches with regard to when OCI treatment would be permissible:

• Approach 1. An entity would have the option on initial recognition of designating any equity instrument as at fair value through OCI. The designation would be irrevocable and made on an instrument-by-instrument basis. On derecognition of an instrument the amount in OCI would be transferred to retained earnings. Disclosures would be required to make transparent why an entity has invoked the option and what the effect on the financial statements has been.

• Approach 2. Designation as at fair value through OCI would be governed by a principle. A possible starting point for such a principle would be as follows:

  An equity instrument that is held in a broader business context and not primarily for realising the financial benefits inherent in it shall be accounted for as at fair value through other comprehensive income.

The staff recommended the second approach, with reclassifications in and out of the OCI category required if the strategic relationship in relation to an equity investment changes, such that the principle no longer applies or only begins to apply at a date after initial recognition.

One board member disagreed with the staff position on the basis that the reclassification criteria would introduce added complexity. It was noted that the OCI category is a concession by the board and it would be inappropriate to introduce a new principle. Furthermore it was noted that reclassification criteria could be abused if entities anticipated gains or losses in certain instruments. There was some discussion as to whether a sufficiently robust reclassification model would prevent such abuse. Some board members also commented that the proposed principle lacked clarity.

One board member opined that the prohibiting of reclassifications would introduce sufficient discipline when entities designate which instruments to classify at fair value through OCI and limit the potential for abuse.

Another board member noted the example of an entity which is a venture capital company with a variety of investments. A free choice in designating some investments as at fair value through OCI and others as at fair value through the income statement would result in lack of transparency, and users would need to look at the entire statement of comprehensive income in order to understand results.

However several board members pointed out the fact that appropriate wording for any principle was problematic and may result in the need for copious guidance going forward.

The board voted against a principle-based approach in designating which instruments should be at fair value through OCI. 4 members voted in favour. The board also voted in favour of assessment on an instrument-by-instrument basis in designating.

The staff recommended that IAS 18 should be amended in order to exclude dividends receivable for equity instruments at fair value through OCI from the revenue recognition guidance. There was some discussion as to whether transfers to retained earnings for dividend income could be permissible and IAS 16.41 was cited as a parallel. One board member also noted that guidance would be required in relation to areas such as EPS disclosure and the statement of cash flows. The board agreed with the staff's view with regard to IAS 18.

Transition: retrospective application

The staff took the board through its recommendations around retrospective/prospective application in 12 different areas.

1. Classification model and assessment whether an instrument is managed on a contractual yield basis – the staff recommended retrospective application, however assessment of the contractual yield basis criterion should be based on facts and circumstances as at the date of transition to the new guidance. The board agreed with this approach.

2. Designation of equity instruments fair valued using the OCI method – the staff recommended full retrospective application. The problem of obtaining fair values for equity instruments held at cost is addressed in (8) below. There was no board disagreement to this recommendation.

3. Treatment of available-for-sale reserves for instruments measured at AFS under the current guidance – the staff recommended full retrospective application with amounts in OCI relating to AFS instruments should be reclassified to opening retained earnings if they relate to instruments shown at fair value through the income statement under the new guidance. For instruments treated as AFS under the current criteria which will be required to be measured at amortised cost under the new guidance, issues around impairment calculation are addressed at (7) below. The board agreed with the staff recommendation.

4. Hybrid contracts where an embedded derivative was separated under the old guidance and where the hybrid contract is required to be at fair value under the new guidance – the staff recommended full retrospective application. The fair value of the hybrid contract would be the sum of the FV of the previously separated embedded derivative and the FV of the host which had been disclosed previously under IFRS 7. For treatment of hybrids requiring amortised cost treatment under the new guidance and consequent impairment issues see (7) below. Two board members voiced the opinion that there should be consistency in application across the different areas to as great an extent as possible. The board agreed with the staff's recommendation (9 votes in favour).

5. Fair value option – the staff recommended that the assessment for designation and dedesignation should be required on the date of transition, and that the accounting consequences should be applied retrospectively. There was no board disagreement to this proposal.

6. Effective interest rate – the staff recommended retrospective application for instruments which are measured at amortised cost under the new criteria where there had been a different measurement basis previously. This would involve determining the estimated future cash flows considering all contractual terms of the instrument, fees, transaction costs and premium/discounts and generating an internal rate of return. The staff believed that this would be essential for the requirement to report financial instruments at amortised costs going forward. The board agreed with the staff recommendation.

7. Impairment – the staff recommended prospective application with a requirement for an impairment test at the date of transition, and any impairment charge recognised in profit or loss. The board considered whether retrospective application might be possible. One board member opined that a stream of cashflows would be available from previous fair value calculations in order to perform a retrospective impairment assessment, however it was pointed out that some fair values are derived from quoted prices where there is no stream of cashflows used in the calculation. Another board member noted that there may be a large adjustment if there is prospective application. Another board member suggested an alternative treatment whereby the fair value of an instrument as a proxy for the impaired amount for the purposes of recording impairment retrospectively. There was some discussion about whether cash flows should be used where available for a retrospective calculation and, where this was not possible, fair value should be used as a proxy. It was noted that reversals in periods prior to presentation would not cause problems as any current impairment calculation would override previous impairments. It was concluded that the staff should explore the possibility of using fair value in this context.

8. Financial instruments measured at cost – the board had already agreed that the exemption for unquoted equities from fair value measurement should not be retained under the new classification system. The staff suggested that the fair value for these instruments should be determined at the date of transition and the difference recognised in profit or loss on transition. The question was raised by two board members why the difference should not be taken to retained earnings on transition as an adjustment of the opening position as per an IAS 8 change in accounting policy. However it was pointed out that it would be too difficult to fix which periods the change in FV would belong to.

9. Hedge accounting – the staff proposed the view that any hedge relationship which has to be dedesignated under the new criteria should be treated as a discontinuation of hedge accounting. This would provide transitional relief for preparers as it would not be necessary to identify and reverse any hedge accounting effect retrospectively. One board member commented that it would be difficult to interpret this transitional provision given that the guidance on hedge accounting would not be out in July 2009. The staff noted that the fair value option was still available to eliminate mismatches in cases where hedges were discontinued and hedged items would otherwise have been required to be measured at amortised cost. There was no board disagreement to the staff proposal.

10. Disclosure – the staff proposed no transitional relief in the requirement to disclose comparative amounts under IFRS 7 relating to the new classification and measurement system. The board agreed and there were no dissenting opinions.

11. Disclosure on transition – the staff did not propose any requirements additional to the provisions already included in IAS 8.28 for initial application of an IFRS. The board agreed with the staff view and there were no dissenting opinions.

12. Comprehensive additional disclosures for early adopters – in order to ensure comparability between entities the staff proposed the following disclosure requirements for early adopters:
    • An additional statement of financial position in accordance with current IAS 39 for all periods presented
    • An additional statement of comprehensive income in accordance with current IAS 39 for all periods presented
    • A table comparing the carrying amount under the current version of IAS 39 with the carrying amount under the new guidance per class, for each period presented
    • Narrative information on how the entity applied the new classification model and how the model impacts the entity's financial position and performance in the current and preceding periods

All of the above disclosures would be required for each period until the new guidance becomes effective for all entities reporting under IFRSs.

The staff explained that there had been a high level of correspondence and consultation on the subject of disclosure for early adopters. The rules in effect would produce a high barrier to early adoption. On board member commented that the requirements appeared excessive; however, he understood the need for them.

The staff suggested an alternative view whereby disclosure requirements for early adopters would be limited to disclosure on the effect of choices made, as compared to the position pre-transition. The chairman suggested that this could be published as an alternative view within the exposure draft.

Another board member commented that, if the new requirements are superior, the board ought not to place high barriers to early adoption. This view was supported by another board member. The staff commented that comparability was the only reason for the proposed disclosure requirements. The chairman suggested that views should be passed to the staff in the week of 15 June 2009 in relation to the potential alternative view.

Consequential amendments to IFRS 1

The staff proposed some consequential amendments to IFRS 1 in relation to designation date option (that is, the option to designate financial instruments either at the date of initial recognition or the date of transition to IFRSs) and some implementation guidance-related issues, including guidance on embedded derivatives as well as classification and measurement issues. Board members asked whether it was necessary to include this in the first phase of the project, or whether it would be more sensible to postpone IFRS 1 amendments to the second phase.

Consequential amendments to IFRS 7

The staff presented consequential IFRS 7 amendments to reflect the new categories and eliminate disclosure for areas no longer relevant (such as reclassifications). There were no dissenting opinions from the board.

Sweep issues

The staff presented four other issues to the board as follows:

1. The staff did not propose to address the issue of scope of IAS 39 in this phase of the project. The board agreed with the staff suggestion.
2. The staff recommended that there should be no changes proposed to the requirements around day 1 gains and losses in the exposure draft. The board agreed with the staff recommendation.
3. The staff noted that two of the annual improvements to IAS 39 to be included in the forthcoming exposure draft, in relation to effective interest rate and bifurcation of embedded derivatives, may no longer be relevant. It was noted that the exposure draft for the annual improvements would have an effective date of 1 January 2011, and that the effective date for the revised classification and measurement requirements may be 1 January 2011 or 1 January 2012. One board member voiced support for an effective date of 1 January 2012, since all of the proposed amendments ought to apply at the same time. It was decided to include the question in the September exposure draft for annual improvements.
4. The staff did not recommend any changes to the IAS 39 measurement guidance in relation to financial guarantee contracts, loan commitments or financial liabilities with a demand feature. The board agreed with the staff position.

Final discussions

The chairman stressed that, if appropriate, alternative views could be expressed in the exposure draft in relation to the new classification and measurement rules. One board member held an alternative view which was supported by another board member. The chairman suggested that the alternative view should be discussed between the board member and the staff and that a further discussion would be held on Friday, 19h June 2009.

The board member gave a brief outline of the alternative view. This was that, for certain debt instruments which were not loans and receivables, income could be presented in the income statement but fair value movements through OCI. Thus fair value information would be given on the balance sheet and also an amortised cost-based income stream in the income statement whilst preserving the fair value basis. As such the amortised cost model would only be retained for loans and receivables. However the same criteria would exist for classification at amortised cost (i.e. managed on a contractual yield basis). It was concluded that a paper would be produced, summarising this view.

The chairman noted that this alternative view and that for disclosures on early adoption should be discussed on Friday, 19 June 2009.

Wednesday 17 June 2009 – Education Session by Bank of Spain (BdE) Representatives: the BdE Provisioning Model

Two representatives from the Bank of Spain (regulator of Spanish banks) presented the statistical provisioning approach which the BdE requires from entities regulated by them. The representatives explained that, in their opinion, the model incorporates losses incurred due to under-pricing of credit in times of boom in the lending cycle due to market over-optimism. The lending cycle per the model is closely correlated with the economic cycle as a whole.

The model is based on a statistical formula which incorporates an element of collective impairment relating to the point in the lending cycle ('alpha') and incurred losses relating to individual assets ('beta'). The alpha component is a collective assessment and applied to the change in the portfolio of assets at each date of assessment. Thus in times of boom in the lending cycle, the alpha component is high relative to the beta component, whereas this trend is reversed in times of slump as incurred losses relating to the general cycle are in effect transferred to individual assets; the alpha element can be negative, reflecting over-conservative pricing of credit. The representatives explained that they believe the advantage of the model is the early detection of credit losses.

The Bank has around 6 asset classes which it views as homogeneous, for each of which an alpha (effect on asset class of stage of the lending cycle) and beta (historical incurred losses relating to individual assets) are kept. In order to assess the lending cycle, the BdE holds data from the Spanish national credit register dating back to 1988 for each of the asset classes, which equates roughly to 2 full lending cycles. The representatives stressed that this is an incurred loss model as the inputs to the model are derived only from historic experience.

Board members asked questions around various aspects of the model. One member asked what approach the BdE takes for new products where there is little historic data. The representatives replied that this was not an issue that had caused much difficulty in Spanish banking given the relative absence of new products – for example, credit cards represented only around 1% of total lending in Spain. Another member pointed out that, for loans given out during periods of boom, the model effectively results in a large 'day 1'-type loss for lenders. The representatives replied that this was a necessary reflection of credit pricing in these times.

Another member asked whether BdE was aware of how much credit data other central banks held, and thus how practicable a system such as this would be for banks from other countries. The representatives replied that they were aware of some central banks holding extensive credit data; however it was unlikely that many would hold data in sufficient detail going back as far as 1988. Another board member asked whether, if an expected loss model were incorporated within IFRS, the bank would continue to use its model. The representatives replied that, in their opinion, it was possible to use the model to estimate expected losses, however it would be a relatively simple approach. The representatives agreed with board members' views that, were this model adopted more widely, more active involvement would be required from banking supervisors in assessing provisioning than is currently the case given the complex nature of the model and underlying data. The representatives put forward the view that, in times of economic difficulty such as the present time, banks would be less likely to voice the view that an approach such as their model would lead to competitive disadvantage. This had been their experience in Spain.

The chairman thanked the representatives for their presentation.

Friday 19 June 1009 – Transition: Disclosure Requirements for Early Adopters

The staff noted that the Board's forthcoming proposed amendments to IAS 39 would be effective for annual financial years beginning on or after 1 January 2012, with early adoption permitted.

The Board considered staff proposals designed to address Board members' concerns that disclosures would be required for early adopters to increase comparability with entities that do not adopt early. The staff noted that IAS 8.28 already requires extensive disclosure in the year of initial application of an IFRS. However, they maintained their view that additional disclosures for early adopters were necessary to assist users in comparing the financial position and performance of entities adopting the amendments before the mandatory application date. However, they acknowledged a need for a balanced approach, so that any disclosure was not overly onerous so as to discourage early adoption.

The staff clarified that these proposed disclosures would not apply to first time adopters, and that an amendment to IFRS 1 would be made to clarify this (the disclosures address the transition from the current IAS 32/39 model to the proposed model, not adopting the new model from a previous GAAP).

The Board agreed (one opposed) that the following disclosures (additional to those required by IAS 8.28) should be made in the year of adoption if the final requirements are adopted before the mandatory application date.

• (a) A table displaying all financial instruments, aggregated by class as defined in IFRS 7, whose measurement basis or the presentation of gains or losses had changed as a result of applying the new guidance, disclosing:
  • (i) the original and new measurement basis
  • (ii) the original and new carrying amount
  • (iii) the reasons for the change in the measurement basis or presentation method.
• (b) a table displaying the reclassified amounts as a result of any:
  • (i) designations into the fair value option including the original measurement bases (and presentation method) and carrying amounts;
  • (ii) designations out of the fair value option distinguishing between permitted and required dedesignations including the original measurement bases (and presentation method) and carrying amounts; and
  • (iii) the reasons for any such designation and dedesignation.

One Board member thought that, while he understood the intention of the proposed disclosure, the result would be ineffectual boilerplate. The revised standard would permit changes in presentation and measurement, and a preparer might legitimately state in the footnote that the entity had adopted a new accounting policy because the IASB allowed it to do so! Other Board members thought that this position was extreme, and that a sensible application of the requirements would yield the appropriate disclosure.

There was some concern among Board members about how the proposed disclosure would apply to interim reporting. The staff agreed to confirm the implications of their proposals on interim reporting and revert to the Board if necessary. If no Board decision was necessary, the interim reporting consequences would be explained in the exposure draft.

Friday 19 June 1009 – Description of Possible Alternative Features to the Exposure Draft Model

The Board discussed a proposal put forward by a Board member describing some additional features (variants) of the classification model developed by the Board. Under this variant:

• (a) Financial assets with basic loan features that are managed on a contractual yield basis would be measured at fair value in the balance sheet, unless they meet the definition of loans and receivables in IAS 39.
• (b) Such financial assets would:
  • (i) be measured on an amortised cost basis in profit or loss (including recognition of impairment using the incurred loss provision requirements in IAS 39); with
  • (ii) any difference between that amortised costs measure and the fair value change being recognised in other comprehensive income. There would be no recycling between OCI and profit and loss.

The effect of this proposal was that potentially more financial instruments would be measured at fair value on the balance sheet, but the value change would be allocated between profit and loss and other comprehensive income in the statement of comprehensive income.

Board members discussed this variant for a while, suggesting other possible variations. At least one member thought the variant as 'dead on arrival' and would not support it. Another Board member thought that it was unhelpful to mix the measurement of financial instruments between the statement of financial position and the statement of comprehensive income. If an item was reported on the statement of financial position at fair value, changes in that measure should be reported in profit and loss. A mixed allocation method, such as proposed with the amortised cost component being reported in profit and loss and the 'plug' between that amount and the value change being reported in other comprehensive income was likely to lead to problems and the Board developed other aspects of the revised financial instruments package.

In particular, some Board members were concerned about the consequences of this variant on hedge accounting, especially that the mixed allocation might add rather than reduce complexity in some situations. If hedging is designed to manage what is recognised in profit and loss, allocating some of the exposure being hedged to other comprehensive income would create challenges in hedge accounting, in particular assessing effectiveness.

While not commenting on its merits, the Board agreed that the variant should be discussed in the forthcoming exposure draft's Basis for Conclusions (as will all the alternatives considered in detail by the Board) and that comments should be invited on it.

Discussion at the July 2009 Joint IASB-FASB Meeting

Russ Golden, FASB Technical Director, outlined the FASB's tentative conclusions on its project on improvements to financial instruments recognition and measurement. He explained that the FASB agreed to propose a model to improve financial reporting for financial instruments. So far, the FASB's tentative decisions were as follows:

• All financial instruments would be presented on the statement of financial position at fair value, with changes in value recognised in net income or other comprehensive income with an optional exception for own debt in certain circumstances, which would be measured at amortised cost. For those financial instruments whose change in value was recognised in other comprehensive income, amortised cost would be displayed on the statement of financial position in addition to a fair value adjustment to arrive at fair value.
• Changes in an instrument's value may be recognised in other comprehensive income on the basis of qualifying criteria related to an entity's business model and the cash flow variability of the instrument. The FASB would provide additional guidance on how to apply those qualifying criteria. FASB will also propose that changes in value of three types of instruments should be recognised in net profit or loss: derivatives, equity securities, and hybrid instruments containing embedded derivatives requiring bifurcation under FASB Statement 133 Accounting for Derivative Instruments and Hedging Activities. In addition, for all financial instruments, interest and dividends would continue to be recognised in net profit or loss. Credit impairments, as well as realised gains and losses from sale and settlement, also will be recognised in net profit or loss. The classification of instruments would be determined at initial recognition of the instrument and would not be subsequently changed (no reclassifications would be permitted).
• One statement of financial performance, with subtotals for net income and other comprehensive income, would be required. The FASB will propose to continue to require earnings per share for net income only.

Mr Golden noted that the FASB's deliberations were less advanced than the IASB's and that certain issues, such as the treatment of demand deposit liabilities and impairment, still needed to be addressed by the FASB.

During the discussion that followed, FASB members and staff clarified and amplified certain points. For example, an IASB member noted that, for a bank, the amortised cost option would almost never apply, since most of the bank's financial assets would be at fair value.

It was noted that what was eligible for the 'amortised cost' category was similar between the IASB and the FASB, but that the treatment was different – especially the measurement in the statement of financial position and the treatment in the statement of comprehensive income. This would be raised with constituents with the view to converging to a common solution.

The FASB Chairman noted that the IASB and the FASB shared a common goal: to deliver a common, high-quality financial reporting standard. The FASB needed more time to complete its deliberations, but acknowledged the pressures on the IASB and the reasons it was pursuing the project in the way it was. The FASB would make its proposed model available in advance of a formal exposure draft – it would probably be available on the FASB's Website by late August 2009. Detailed discussions would be held at the October 2009 joint IASB-FASB meeting and, if necessary, in November.

The IASB Chairman said IASB still had to address impairment and the expected loss model. It is also likely that the IASB would propose a single statement of comprehensive income, so that the financial statement presentation was also aligned between IFRSs and US GAAP.

Roundtable discussions

The FASB and IASB will hold joint roundtable discussions as part of the outreach activities on this common project. These will be held in early September 2009 (before the comment period for the IASB exposure draft on classification and measurement closes) in London, New York (Norwalk?), and Tokyo.

It is likely that a condition of participating in the roundtable would be that a comment letter would have been submitted – or at least a summary comment letter. Board members wanted to be able to engage constituents and discuss their views, rather than help them to identify issues for their comment letters.

Discussion at the October 2009 Joint IASB-FASB Meeting

Presentation

The Boards discussed whether both fair value and amortised cost information should be prominently disclosed on the face of the financial statements (for example, through parenthetical disclosure or reconciling information on the face of the financial statements). One benefit would be to allow investors to more easily compare financial statements prepared under the FASB's and IASB's respective approaches. Additionally, it was noted that some investors are looking for both fair value and amortised cost information in a timely manner. Some questioned whether providing both fair value and amortised cost on the face of the statement of financial position would be confusing to readers of financial statements.

A majority of the IASB members present indicated that they would not necessarily object to requiring entities to provide both fair value and amortised cost information on the face of the statement of financial position for financial instruments that under the IASB's approach are classified as amortised cost. The IASB agreed to consider this issue further at a future board meeting along with the issue of whether requiring prominent disclosure of changes in fair value in separate pro-forma statements to illustrate the impact on accumulated other comprehensive income and shareholders' equity. (The FASB has previously agreed to propose prominent disclosure on the financial statements of both fair value and amortised cost information for financial instruments that under the FASB's approach are classified as fair value through other comprehensive income.)

Core Principles

Subject to further refinement, the two Boards agreed on the following core principles for convergence of the FASB's and IASB's approaches to the accounting for financial instruments (note – the core principles outlined below are based on observer notes of the deliberations and are subject to refinement by the Boards):

1. The new requirements should enhance comparability for the benefit of investors.
2. The new requirements should provide transparency of risk exposures in management business strategies.
3. Prominent and timely fair value information is relevant for financial instruments with highly variable cash flows or held for trading purposes.
4. Both amortised cost and fair value information is relevant for financial instruments with principal amounts held for collection or payment of the contractual cash flows rather than for sale or settlement with a third party.
5. The new requirements should be less complex to implement.
6. The impairment approach for financial assets held for collection of contractual cash flows should be consistent.

Related to principle 4, some Board members expressed concern about the relevance of fair value information for financial liabilities due to the impact of own credit risk on fair value measurements of liabilities. The Boards agreed to post to their respective project websites the core principles for accounting for financial instruments after the refinements are made.

Work Plan for Convergence

The FASB staff informed the Boards that the FASB anticipates issuing an exposure draft on the accounting for financial instruments project in the first quarter of 2010. In addition, the following work plan was identified:

• Both Boards will jointly deliberate improvements to hedge accounting in November and December.
• The expert advisory panel will focus on both the IASB's and FASB's proposed impairment models.
• Understand differences and identify specific financial instruments that will be impacted by the classification and measurement models being developed by the two Boards.
• Jointly deliberate issues related to credit risk in liability measurement.
• Issue final standard in late 2010.

Impairment

The Boards exchanged questions about their respective approaches to credit impairment which focused on what information can be used to determine whether a credit impairment exists. IASB members asked whether the FASB's approach could result in the recognition of a loss on initial recognition of a portfolio of loans if there is an expectation of credit losses in the portfolio. FASB members indicated that they had not yet deliberated the details of FASB's approach. No decisions were made.