On 12 June 2012, the IASB and FASB held two separate insurance sessions. The first one was a two hour educational session on measuring earned premiums. The second was a one hour decision making meeting on the allocation of cash flows to the unbundled component.

Earned premiums

The education session focused on Agenda Papers 2B/84B and 2C/84C on earned premiums; these were very well received by the Boards who commented positively on their quality. The staffs discussed the goal of comparability between insurance and other industries, and the need therefore, to have a “revenue-like earned premium model”, as it was referred to. Most notably, they highlighted Appendix B of Paper 2B, which compares the three approaches outlined in the paper: earned premium, written premium and premium due.

After what appeared to be a beneficial roundtable discussion, the staffs summarised the current status and, going forward, indicated that they will focus their efforts on the earned premium approach, as there was less interest in the other two models. A handful of Board members felt this revenue construct does not mesh well with the other aspects of the project, given the focus has so far been on the liability measurement; this will likely be a topic of continued debate. Other items in relation to this topic will need to be considered by the staffs such as, acquisition costs, other non-claims related cash flows and unit of account.

The staffs will continue their efforts to perform user-specific outreach, and in particular explore whether the benefit of having volume information outweighs the cost incurred by preparers to produce that information, as well as whether it will be of real use.

Allocation of cash flows to unbundled components

The second session focused on Agenda Paper 2A/84A intended to help in the determination of how to allocate cash flows to various components of insurance contracts. For those components that the Boards tentatively decided to unbundle, the staffs recommended that:

1. The cash flows allocated to an investment component and considered in the measurement (including interest credited) should be measured on stand-alone basis which means as if the insurer had issued the investment contract separately (without including the effect of any cross-subsidies or discounts/supplements),
2. After excluding any cash flows allocated to unbundled investment components (or embedded derivatives recognised separately), the amount of consideration and discounts/supplements should be allocated to the insurance component and/or the goods and service component. The allocation should be done in accordance with the current revenue recognition proposals, and
3. Cash outflows related to more than one unbundled component (for example, acquisition and fulfilment costs) should be allocated to those components on a rational and consistent basis. Once allocated, the insurer would account for those costs in accordance with the recognition and measurement requirements that apply to that component.

This topic was also covered in last week’s FASB education session. On both occasions, the focus appeared to be on Board members’ concern over the nature of “allocation”. Nearly all Board members felt the staffs should be clear on what disbursements are eligible for not being treated as an expense because the customer has substantially prepaid them, how to attribute those disbursements to the various components (for example, investment component or revenue component disbursements versus insurance contract disbursements given the different measurement attributes and treatment of the disbursement as costs, assets or deduction of a liability) and then finally for shared costs only, potentially how to allocate them across different component.

Both Boards voted unanimously in favour of the staffs’ recommendations, with a caveat that the attribution versus allocation language will be taken into account when drafting. Most notably, the staffs were asked to draft language such that when cash flows are clearly linked and attributable, those cash flows are kept within the unbundled component and treated according to the standard that governs the financial reporting of that component.

As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards discussed whether there should be different lease expense recognition patterns for different lease contracts in the context of lessee accounting and whether any changes should be made to the lessor accounting proposals as a consequence of the lessee accounting discussions.

The Boards made a number of tentative decisions during these deliberations, as follows:

• The Boards reversed their previous tentative decision and tentatively decided that there should be different lease expense recognition patterns for different lease contracts. A lessee would apply an approach consistent with the Boards’ previous tentative decision (resulting in accelerated expense recognition) to some leases and apply a whole contract approach (resulting in straight-line expense recognition) to other leases (excluding short-term leases). A right-of-use asset and lease liability would be recorded under both approaches.
• A lessee should distinguish between those different leases based on whether the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term. That principle should be applied by using a practical expedient based on the nature of the underlying asset.
• The underlying principle used to distinguish whether the lessor receivable and residual approach applies would be symmetrical with the principle used in distinguishing between the type of lease under the lessee model.

Lease expense recognition patterns

During its May 2012 meeting, the IASB and FASB staff presented to the Boards a summary of the feedback received as part of its outreach regarding the pattern of lease expense recognition resulting from the lessee accounting model. After discussing relevant outreach feedback, Board members directed the staffs to further develop three approaches for discussion during the June 2012 meeting. Those approaches, focused on the subsequent measurement of the right-of-use asset, were as follows:

• Approach A: an approach consistent with the Boards’ previous tentative decision that treats a lease contract as being equivalent to the purchase of an intangible asset that is financed separately thereby resulting in a pattern of accelerated expense recognition;
• Approach B: a “whole contract” approach which considers the right-of-use asset and the lease liability that arise from a lease contract to be one unit of account when initially and subsequently measuring those balances, and thus, requires recognition of the total lease payments evenly over the lease term (i.e., straight-line expense recognition). The lessee would present the total expense each period as lease expense and there would be no separate interest component or amortisation component in the income statement
• A combination approach which applies Approach A to some leases and Approach B to other leases.

At this meeting, the staffs provided an overview of each approach; summarising the rationale, reasons to support the approach and relevant concerns.

In deliberations, individual preferences quickly resolved themselves into board preferences, as a significant majority of IASB members expressed support for application of Approach A to all leases while FASB members generally expressed support for a combination approach which applied Approach A to some leases and Approach B to other leases. No support was expressed for applying Approach B to all leases.

Reasons for supporting a particular approach varied. Specifically, Board members supporting Approach A often noted that it was the most conceptually sound and offered the least complexity since it could be applied to all leases without the need to distinguish between lease types. In expanding on these ideas, Board members noted:

• The expense recognition pattern is conceptually consistent with a right-of-use model, whereby the lessee recognises a right-of-use asset and a lease liability separately. The subsequent measurement of the right-of-use asset, a non-financial asset, and lease liability, a financial liability, is consistent with the subsequent measurement of other non-financial assets and financial liabilities. Board members also noted that application of Approach B to certain leases fails to reflect interest expense for the time value of money and results in an amortisation profile for the right-of-use asset which does not have a conceptual basis.
• Approach A is a coherent model for all leases which reduces complexity and cost for users, preparers and auditors. Further, user feedback during outreach activities expressed a preference for one approach to lessee accounting.
• Development of a principle for determining which expense pattern to apply to each contract will be subject to criticism given a diversity of views amongst constituents.

However, other Board members noted that constituent outreach has indicated that the economics of lease contracts differ. Consequently, these Board members supported a two-model approach that would apply Approach A to some leases and Approach B to others based on the underlying economics of the lease. These Board members acknowledged that constituents may question why, when applying Approach B, the asset and liability is not presented on a net basis given that Approach B links the right-of-use asset and the lease liability. Thus, they indicated that a robust basis for conclusions would be necessary to provide the Boards’ rationale as to why Approach B is appropriate but net presentation on the statement of financial position is not.

Board members were asked to vote on their first preference of applying either Approach A to all leases or a combination of Approaches A and B to all leases. All but one FASB member supported a combination of Approaches A and B, while all but one IASB member expressed support for applying Approach A to all leases (with two IASB members abstaining). As many IASB members expressed a willingness to entertain a combination of Approaches A and B for purposes of convergence, the FASB Chair asked if the IASB would object to applying a combination approach. No objections were raised, with two IASB members abstaining. Therefore, the Boards tentatively decided that there should be different lease expense recognition patterns for different lease contracts (Approach A would apply to some leases and Approach B to others).

Determination of a dividing line for different types of leases

Given the above tentative decision to apply a different pattern of expense recognition to some leases, Board members discussed the line to be used in distinguishing between leases accounted for under Approach A and Approach B. The staffs presented several alternatives for drawing a line, including:

• Option 1: Determination based on the transfer of substantially all of the risks and rewards of ownership (using the principle outlined in IAS 17 Leases)
• Option 2: Determination based on whether the right-of-use asset represents the acquisition of a more than insignificant portion of the underlying asset
• Option 3: Determination based on the nature of the underlying asset (e.g., leases of property versus leases of assets other than property)
• Option 4: Determination based on the lessee’s business purpose for entering into the lease arrangement.

Many Board members expressed a view that Option 4 was not operational. They noted that this underlying principle in this option is based on the intention of the lessee in determining whether the lease transaction was primarily entered into as a financing arrangement or not which may create comparability issues for users. Therefore, no support was expressed for this alternative.

Two FASB members expressed support for Option 1 on the basis that it incorporates a residual risk consideration when applied under the lessor model and promotes a smoother transition between current accounting and the proposed lease model (given that the IAS 17 criteria are well known in practice). However, other Board members expressed concerns that the IAS 17 criteria were developed for a different purpose than use under a right-of-use model, and given the nature of the criteria, it may inappropriately result in a significant number of leases being classified under Approach B (above).

Many Board members were unclear as to the distinguishing characteristics between Options 2 and 3. The staffs acknowledged that Option 3 was considered a practical expedient of Option 2 where the staffs considered that conclusions would generally be consistent applying either option. Under Option 2, for leases in which the right-of-use asset represents the acquisition of more than an insignificant portion of the underlying asset, a lessee would apply the accounting treatment in Approach A above.

However, for leases in which the lessee is not consuming a more than insignificant portion of the underlying asset, a lessee would apply Approach B. Under Option 3, the line would be based on the type of underlying asset. Leases of property would generally be accounted for using Approach B above unless the lease term is for the major part of the economic life of the underlying asset or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset.

Leases of assets other than property would be accounted for under Approach A above unless the lease term is an insignificant portion of the economic life of the underlying asset or the present value of the fixed lease payments is insignificant relative to the fair value of the underlying asset. According to the staffs’ agenda papers, most property leases would be accounted for using Approach B while most leases of assets other than property would be accounted for under Approach A.

While some Board members supported Option 2, they expressed concerns with the introduction of a new concept (i.e., consumption). Other Board members expressed concern that Option 3 simplified the economics too significantly. However, many Board members saw Option 3 as effectively introducing a rebuttable presumption to Option 2. Therefore, they preferred that Options 2 and 3 be combined in some capacity.

When put to a vote, the IASB had a clear majority of 10 votes for Option 3. However, the FASB had a split vote (two members supported Option 1, two members supported Option 2 and three members supported Option 3). The IASB Chair asked if either Board would object to developing a principle based on consumption (consistent with Option 2) (i.e., whether the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term) but providing a practical expedient based on the nature of the underlying asset(Option 3). No objections were raised.

Consequences of lessee decisions on lessor accounting

Given the above tentative decisions, the Boards discussed whether there should be consequences for lessor accounting resulting from the lessee accounting discussions.

Board members supported changing previous tentative decisions on the lessor model as a result of tentative decisions taken on the lessee model.

The staffs presented three possible approaches to progressing the lessor model following tentative decisions taken on the lessee model:

• applying a symmetrical model between lessees and lessors where the dividing line used to distinguish leases in the lessee model should also be applied in distinguishing use of the lessor model
• developing a new dividing line for lessors which is based on the lessor business model
• developing a new dividing line for lessors which is based on the IAS 17 principle of an in-substance sale. Ultimately, such a dividing line would be used to determine which leases would be within the scope of the lessor receivable and residual approach.

Many Board members thought the lessee and lessor accounting models should be linked and generally symmetrical, with any instances of asymmetry clearly explained in the basis for conclusions.

Other Board members noted that lessees and lessors have fundamentally different reasons for entering into leases, and thus, were satisfied with asymmetry between the lessee and lessor accounting models (although one IASB member questioned whether a decision to abandon symmetry between the lessee and lessor model could open up the possibility of excluding lessors from the leases project altogether given that constituents have not historically expressed a view that the IAS 17 model for lessors was broken).

A few Board members expressed a preference that the lessor model be aligned with the revenue recognition proposals as opposed to the lessee model. They noted that the lessor model should consider residual risk, akin to revenue recognition proposals, in determining whether any day 1 profit should be constrained and recognised over time. Therefore, these Board members expressed a preference that the lessor model include a constraint on profit which considers residual risk. However, the staffs noted that the incorporation of a constraint was considered in July 2011 in applying a ‘reasonably assured’ criteria but was rejected by the Boards.

When put to a vote, the Boards (with 4 votes from the FASB and 11 votes from the IASB) tentatively decided that a symmetrical model should be applied between lessees and lessors where the dividing line used to distinguish leases in the lessee model would also be applied in distinguishing use of the lessor receivable and residual model. Thus, for leases in which the lessor is deemed to have sold (lessee consumed) a more than insignificant portion of the underlying asset to the lessee, the lessor would reflect the accounting under the receivable and residual approach. However, for leases in which the lessor is not deemed to have sold a more than insignificant portion of the underlying asset to the lessee, the lease would not be within the scope of the receivable and residual approach and would apply an approach similar to operating lease accounting.

The Boards continued their discussion on reducing differences between the classification and measurement guidance in IFRS 9 and the FASB’s tentative classification and measurement model.

Scope of fair value through other comprehensive income for debt instruments

During the May joint Board meetings, the Boards tentatively decided to introduce a fair value through other comprehensive income (FVTOCI) category for debt instruments with amortised cost and FVTOCI having defined business models and fair value through profit or loss (FVTPL) being a residual category. Under both IFRS 9 and the FASB’s tentative model, instruments that do not meet the contractual cash flow characteristics assessment (i.e. solely principal and interest) would be measured at FVTPL.

During this meeting the Boards were asked whether an instrument would have to pass the contractual cash flow characteristics assessment to be classified as FVTOCI. The Boards both agreed that the FVTOCI category should only be available for financial assets that pass the contractual cash flow characteristics assessment and are managed within the relevant business model.

Fair value option

IAS 39 Financial Instruments: Recognition and Measurement provided a fair value option for both financial assets and liabilities if 1) doing so eliminates or significantly reduces an accounting mismatch, 2) a group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair value basis or 3) the financial asset or financial liability contains one or more embedded derivatives and the entity elects to account for the hybrid contract in its entirety. IFRS 9 retained the eligibility conditions for designating financial liabilities under the fair value option, but on the basis that two of the eligibility conditions for designating financial assets under the fair value option were considered unnecessary under IFRS 9, IFRS 9 currently permits a fair value option for financial assets only when doing so would eliminate or significantly reduce an accounting mismatch.

The FASB’s tentative model currently includes a fair value option for a group of financial assets and financial liabilities if the entity manages the net exposure relating to those financial assets and financial liabilities (which may be derivative instruments) and the entity provides information on that basis to the reporting entity’s management. The FASB’s model also includes a conditional FVO for both hybrid financial assets and hybrid financial liabilities to avoid bifurcation and the separate accounting for an embedded derivative. However, based on the tentative decisions made during the May joint meetings, hybrid financial assets are not eligible for bifurcation.

The FASB staff recommended an irrevocable fair value option for financial assets at initial recognition when doing so eliminates or significantly reduces a measurement or recognition inconsistency. For financial liabilities, the FASB staff recommended an irrevocable fair value option at initial recognition when doing so results in more relevant information because it either eliminates or significantly reduces a measurement or recognition inconsistency or a group of financial liabilities or financial assets and financial liabilities managed and its performance evaluated on a fair value basis in accordance with a documented risk management or investment strategy. For hybrid financial liabilities, the FASB staff recommended an irrevocable fair value option at initial recognition unless the embedded derivative does not significantly modify the cash flows that otherwise would be required for the contract or it is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative is prohibited.

One of the FASB members expressed his concerns with the staff recommendation stating that he did not support options and would prefer a requirement to measure item(s) at fair value if certain criteria are met. The FASB Chair expressed similar concerns. The Board members discussed how to set the appropriate criteria for requiring fair value measurement of financial liabilities or groups of financial assets and financial liabilities. The FASB Chair asked the staff if the revised criteria being discussed would address the needs of constituents for a fair value option if it were presented as an option rather than a requirement and the staff agreed. The FASB tentatively decided to provide an irrevocable fair value option at initial recognition for hybrid financial liabilities unless the embedded derivative or derivatives do not significantly modify the cash flows that otherwise would be required by the contract or it is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative is prohibited. The FASB also tentatively decided to provide an irrevocable fair value option at initial recognition for a group of financial assets and liabilities if the entity manages the net exposure relating to those financial assets and financial liabilities (which may be derivative instruments) on a fair value basis and the entity provides information on that basis to the reporting entity’s management.

The IASB tentatively decided to extend the current fair value option in IFRS 9 for financial assets to debt investments that would otherwise be measured at FVTOCI if doing so eliminates or significantly reduces an accounting mismatch.

The Boards continued their re-deliberations of their respective proposals on investment entities.

Accounting by an investment entity parent for an investment entity subsidiary

The Boards discussed the accounting by an investment entity parent for an investment entity subsidiary under two separate scenarios. The first scenario was that of a master-feeder fund structure where a feeder fund’s only investment would be in a master fund (typically two feeder funds invest in a master fund and are all managed under a common control structure) which actually holds the underlying investments. The second scenario was that of a fund-of-funds structure where an investment fund may invest in numerous other investment funds (some funds may be managed by the investment manager while other funds may be managed by third-party investment managers).

The IASB’s exposure draft proposed that investment entities would measure all controlled investees at fair value, regardless of whether the investee is an operating entity or an investment entity (unless the entity provides services to the investment entity). The FASB’s exposure draft proposed that investment entities would consolidate controlling financial interests in a fund-of-funds structure but that a master-feeder structure would be measured at fair value because current practice includes attaching master fund financial statements to the financial statements of a feeder fund which provides transparency in to the investment activity for investors in the feeder fund.

Constituents generally disagreed with the FASB’s proposals regarding consolidation of a fund-of-funds structure as doing so would distort the financial statements. Constituents felt that the FASB’s concerns regarding transparency could be addressed through expanded disclosures rather than consolidation.

The staffs recommended that for master-feeder structures the feeder fund should not consolidate a controlling financial interest in a master fund and instead should record its interest in the master fund at fair value. Additionally, all feeder funds should include master fund financial statements along with those of the feeder fund. For fund-of-funds structures, the staffs recommend that an investment entity measure all investment entity subsidiaries at fair value.

Many IASB members referenced the scope of the IASB project as providing an exception to consolidation for investment entities but not providing investment entity guidance and questioned the recommendation about requiring an entity to provide financial statements for a subsidiary as being outside of their scope. Some IASB members felt that a requirement to attach subsidiary financial statements was a regulatory issue rather than an accounting standard setting issue. However, other IASB members felt that requiring disclosures when providing an accounting exception was perfectly within the scope of the project.

The FASB members generally supported the staff recommendation but questioned whether defining master-feeder structures and requiring the inclusion of master fund financial statements would require re-exposure. The FASB members raised the issue that without the inclusion of master fund financials a feeder fund financial statement would essentially be only a one line item balance sheet and income statement. One FASB member questioned why the proposals should be different between a master-feeder and a fund of funds structure and suggested that fund-of-funds structures should be required to attach financial statements for any investment material.

The IASB tentatively decided to retain the proposals in their exposure draft that an investment entity would account for all investments at fair value except for those controlled entities that provide services to the entity which would be consolidated. The IASB also tentatively decided not to require the inclusion of investment entity subsidiary financial statements but would consider the issues on transparency as part of the disclosure discussions during a future meeting.

The FASB also tentatively decided that an investment entity would account for all its investments at fair value except for those controlled entities that provide services to the entity (and investment properties which is being re-deliberated in a separate project) which would be consolidated. The FASB also tentatively decided to require a feeder fund to include the financial statements of a master fund as part of its financial statements. The FASB highlighted that they would need to consider their decision on fair value accounting for controlled investment entities and any conflicts with the requirements under the SEC’s 1940 Act and that they would also need to define a master-feeder structure at a future FASB-only meeting.

Accounting by a non-investment entity parent for the investments of an investment entity subsidiary

The IASB’s exposure draft proposed that a non-investment entity parent would be required to consolidate all entities it controls including those controlled through an investment entity. In other words, a non-investment entity parent who consolidates an investment entity, would not be allowed to retain the fair value accounting for the investment entities investments at the non-investment entity parent level. The IASB’s exposure draft referenced potential accounting inconsistencies and the potential for abuse.

The FASB’s exposure draft retained the existing practice in US GAAP for a non-investment entity parent to retain the specialised accounting of a consolidated subsidiary (i.e. carryover fair value accounting at the parent level).

Nearly all FASB constituents and the majority of IASB constituents supported the US GAAP approach of retaining fair value accounting of an investment entity in consolidation by a non-investment entity parent. These constituents felt that the specialised accounting by the investment entity continues to be relevant at the non-investment entity parent level, that the cost savings and benefits of more relevant reporting would be lost if fair value accounting was not retained, and that retention of fair value would be consistent with the IASB’s proposals for non-investment entity parents’ interests in associates and joint ventures. They also felt that the IASB’s concerns regarding the potential for structuring were overstated and could be addressed through the criteria to qualify as an investment entity.

The staffs considered an alternative between the two Boards’ proposals which would require only some non-investment entity parents to retain the specialised accounting (for example, entities with characteristics of investment entities but did not qualify because they also include other activities). However, the staff viewed such an approach as being over complex.

One IASB member noted that fair value information regarding investments provides more relevant information and that holds true at the parent level. However, other IASB members expressed concern over the retention of fair value accounting. One IASB member referred to a section of the agenda paper discussing the revised definition of an investment entity (as tentatively decided at the May joint Board meetings) which stated that an investment entity and its affiliates cannot obtain any returns or benefits from their investments other than capital appreciation or capital appreciation and investment income and therefore this would prevent investment funds from qualifying as investment entities if the parent were to also receive other benefits. He questioned the staffs how much of a constraint the revised definition provided. The staffs had differing views on the question, the FASB staff felt that this was sufficient as it would scope out those instances of non-investment entity parents avoiding consolidation but receiving benefits such as supply chain, research and development or other benefits. However, the IASB staff viewed the revised definition of an investment entity as expanding the population of those entities within the scope of the investment entity definition.

The FASB tentatively decided to require retention of fair value accounting by a non-investment entity parent of an investment entity. The IASB tentatively decided to require non-investment entity parents to consolidate all entities they control, even when held through an investment entity.

In 2007, the Trustees added a post-implementation review process (PIR) of each new IFRSs or major amendment as a mandatory step to the IASB’s due process requirements. Phases of the PIR include an initial assessment and public consultation phase and an evaluation of evidence and presentation of findings phase.

At this meeting, the staff requested permission to publish a Request for Information (RFI) regarding the effect of implementing IFRS 8 Operating Segments as part of the public consultation phase of the PIR. As tentatively agreed at the May 2012 meeting, the structure of the proposed RFI would be based on the key decisions that were made when the IASB developed IFRS 8. These decisions included:

• identifying segments based on the management approach;
• measuring disclosed line items on the basis used for internal reporting; and
• disclosing only those line items regularly reviewed by the chief operating decision maker.

The staff also proposed including further questions in the RFI on the identification of implementation issues and unexpected costs, the disclosure requirements of IFRS 8 and information about respondents. The IASB discussed, and gave comments on, the content and style of the questions proposed. Comments were primarily related to whether the questions posed were too ‘open ended’. Specifically, multiple Board members preferred to have more direct questions to uncover fatal flaw issues (e.g., Are you satisfied with IFRS 8 or would you prefer a new standard?). They feared the open ended questions proposed in the RFI would result in constituents voicing general concerns with IFRS 8; thus forcing the Board to re-open the entire standard. However, other Board members preferred the open ended questions proposed by the staff in order to understand all perceived flaws in the standard.

Ultimately, the IASB agreed to the staff's request to publish an RFI, structured in accordance with the staff's proposals. The IASB plans to consider responses to the RFI at a future date in conjunction with considering the results of planned outreach activities (primarily in the form of workshops with preparers, users, auditors, national standard setters and other accountancy organisations) on the effect of implementing IFRS 8.

The IASB also discussed preliminary findings of a review of academic literature currently available on the effect of applying IFRS 8. In those discussions the IASB identified some areas in which future academic research would be welcome, such as the effect of the implementation of IFRS 8 on interim reporting. The IASB plans to consider academic literature at a future date in advance of completing its post-implementation review of IFRS 8.

The IASB received an update from the May 2012 meeting of the IFRS Interpretations Committee (Committee).

Considering the contents of the IFRIC Update newsletter drafted subsequent to the Committee’s May 2012 meeting, one IASB member requested clarification as to the Committee’s intentions regarding the issue of recognition of a regulatory asset or regulatory liability when a regulated entity is permitted to recover costs or required to refund some amounts independently of the delivery of future services.

The Committee previously deferred further work on this issue in anticipation of the Board potentially considering a similar project as part of its future agenda. While the IASB identified rate-regulated activities as a priority project during its May 2012 meeting, it did not determine a definitive timeline for taking this issue to its agenda. Therefore, the Board member asked the staff whether the Committee intended to take this issue onto its agenda.

The staff indicated that it intended to inform the Committee of the results of Board discussions at a future meeting. However, the staff did not anticipate the Committee adding this issue to its agenda given that the Committee had observed that the issue was too broad for the Committee to address within the confines of existing IFRSs and the conceptual framework.

Absent the above, Board member feedback was limited to clarification of the pervasiveness of certain issues raised to the Committee.

The IASB discussed two issues recently considered by the Committee.

IAS 28 Investments in Associates and Joint Ventures – Application of the equity method when an associate’s equity changes outside comprehensive income

At its March 2012 meeting, the Committee considered a request to correct an inconsistency between the requirements of IAS 28 (revised 2011) and IAS 1 Presentation of Financial Statements (revised 2007) regarding the description and application of the equity method and clarify the accounting for the investor’s share of changes in the investee’s net assets that are not recognised in the investee’s profit or loss or other comprehensive income and are not distributions received (e.g., movements in other reserves of the associate or gains and losses arising on an associate’s transactions with non-controlling interests of its subsidiaries).

At that meeting, the Committee affirmed certain principles. Namely, where an investor’s share ownership interest in the associate is reduced, whether directly or indirectly, the affect of the change should be recognised in profit and loss of the investor; and where an investor’s share ownership interest in the associate increases, whether directly or indirectly, the affect of the change should be accounted for as an incremental purchase of the associate and should be recognised at cost.

The Committee decided not to address equity settled share-based payments of the associate and written call options issued by the associate for an asset because of concern about the complexity of these types of transactions. Therefore, the Committee instructed the staff to recommend to the IASB that IAS 28 (revised 2011) should be amended to incorporate the tentative principles established from previous meetings but not to address equity-settled share-based payments or written call options.

At this meeting, the staff asked the Board if it agreed with the Committee recommendations. Many Board members believed that the most important question that needs to be addressed is whether, for the purposes of accounting for other net asset changes in associates, the equity method should be treated as a one-line consolidation methodology or a valuation methodology. They noted that IAS 28 currently requires certain aspects of the equity method to be applied using a consolidation type methodology, while other aspects require the use of a valuation methodology, which is acknowledged in paragraph 26 of IAS 28. Coupling with this more broad concern, many Board members were troubled that the Committee’s recommendation would not address equity settled share-based payments of the associate and written call options issued by the associate for an asset.

Through deliberations, Board members expressed support for IAS 28 having as its core principle a consolidation methodology for purposes of accounting for other net asset changes in associates. The Board requested that the staff bring back an agenda paper to a future meeting which applies a one-line consolidation ideology and considers whether changes in the parent’s share of other net assets should be recognised in equity, other comprehensive income or profit or loss.

IFRS 1 First-time Adoption of International Financial Reporting Standards – Meaning of effective IFRSs

At its May 2012 meeting, the Committee considered a request to clarify the meaning of ‘effective’ in paragraph 7 of IFRS 1 when the issuance of an IFRS which is not yet mandatorily effective results in two possible versions of an IFRS that are potentially effective at the end of an entity’s first IFRS reporting period.

At that time, the Committee noted that if a new IFRS is not yet mandatorily effective but permits early application, the entity would be permitted, but not required, to apply that IFRS in its first IFRS financial statements provided that the IFRS is applied throughout all periods presented in its first IFRS financial statements.

The Committee observed that the requirement in paragraph 7 was clear, but acknowledged necessary clarifications to paragraph BC11 to avoid misunderstanding. Consequently, the Committee decided to recommend that the IASB amend BC11 through Annual Improvements by adding a new paragraph in the Basis for Conclusions.

At this meeting, the staff provided the IASB with the draft revision to the Basis for Conclusions to clarify the meaning of ‘effective’ IFRSs and recommended its inclusion in the next Annual Improvements cycle. With no objections, the IASB tentatively agreed with the recommendation to amend IFRS 1 as part of the annual improvements project.

Acquisition costs

On 14 June, the IASB members held an education session to discuss the treatment of acquisition costs (Agenda paper 2D) to give a directional steer to the staff.

The discussion followed on from the May meeting where the IASB members expressed a view that they prefer to include acquisition costs as part of the cash flows of an insurance contract instead of recognising them as an expense or a separate deferred costs asset. At the same May meeting, the FASB expressed a strong preference for recognising acquisition costs as an asset. To achieve convergence, the FASB members also voted to consider an approach that would on occurrence of acquisition costs recognise a reduction in the insurance contract residual/single margin with no impact on the statement of comprehensive income.

This educational session produced a lively debate on several issues surrounding this topic. Board members asked staff to explain whether the inclusion of acquisition costs as a component of the contract’s cash flows would not implicitly adjust the residual margin and therefore the emergence of profit from the release of the residual margin. They also asked whether, if this interpretation was confirmed, it would not be preferable for the new accounting standard to require a separate run-off model for the acquisition costs component. The staff, supported by other members of the Board, clarified that while inclusion of acquisition costs would always reduce the margin irrespectively of whether these costs were treated as a component of the contract’s cash flows or as a direct deduction from the residual margin, the pattern of release of the margin could be determined essentially out of three possible options.

To illustrate these options, the staff invited the IASB to consider a simple example where premium is CU 100, acquisition costs are CU 50 and residual margin is CU 50:

• Option 1 – would recognise acquisition costs of CU 50 as an incurred expense and immediately recognise revenue of CU 50 from the premium received. The net result would be no profit or loss at the point of sale of the insurance contract but with revenue and expenses recognised at initial recognition. The remaining CU 50 or residual margin would be earned subsequently over time
• Option 2 – would recognise revenue over time as CU 50. The impact on the net result would be the same as under option 1 but the accounting would not result in revenue and expenses being recognised at initial recognition because the acquisition costs would be treated as the first actual payout of the contract expected liability (balance sheet transaction) or as a direct deduction from the initial residual margin
• Option 3 – would recognise revenue of CU 100 and release acquisition costs of CU 50 over time. Also, in this case, there would be the same impact on the result at initial recognition as in options 1 and 2 and the same impact on the initial recognition of revenue and expenses as in option 2. However the subsequent revenue and expense would be greater than option 2 given that the acquisition costs are amortised separately from the earning of the premium.

One member noted that he would like to avoid distorting volume information and he would not favour options that do not reflect premiums received. Option 1 to release some of the margin and recognise revenue as the acquisition costs are incurred would result in revenue being recognised before in many cases there is coverage. Many considered this counter-intuitive.

At this point, some members suggested reopening the debate on expensing the acquisition costs, especially because the inclusion of costs incurred for unsuccessful efforts makes it hard to find an amortisation driver. The question of successful and unsuccessful efforts was then explored further. Some felt that given the latest decision on unit of account result in more granular level of aggregation of insurance contracts, it may be preferable for acquisition costs to be accounted for with reference to individual contract rather than a portfolio. This would eliminate the need to include acquisition costs of unsuccessful efforts and align the IASB to the FASB preferred model. Others noted that the term unsuccessful efforts was misleading because only the total acquisition expenses incurred faithfully represent the insurer’s contract acquisition activity and the cost of the successful efforts is only faithfully reflected by the total acquisition expenses incurred. If all the efforts were unsuccessful, there would be no portfolio so those efforts would be expensed. The staff reminded the IASB that acquisition costs relate only to acquisition efforts and not to other expenses arising in the course of service, such as claims handling. Further, the treatment would be the same regardless of whether all acquisition costs were paid upfront or spread and paid over the term of the coverage.

A few members noted that expensing these costs is more natural and the more exceptions are made the more complicated the issue becomes. Others felt that if expensing is not an option than a contract asset similar to revenue recognition project would keep the two standards aligned.

A new comparison was then made with existing accounting literature for financial instruments where for instruments at fair value through income the transaction costs are expensed. Some members and staff reminded the IASB that the decision to treat acquisition costs as contract’s cash flows was primarily driven by the objective of producing the proper measurement of liability and to prevent the recognition of day one losses for economically profitable contracts. The prohibition of day one profit and the accounting for a residual margin could be argued to be a departure from liability recognition in other accounting standards. The treatment of acquisition costs is then consistent with the treatment of the residual margin under the current fulfilment value approach the IASB has selected for insurance contracts.

The staff concluded their education session presenting the arguments for and against recognising an asset. The “pros” included that it would be easier to amortise and present, it reflects the value of intangible relationship and that any form of deferral is essentially akin to recognition of an asset explicitly or implicitly. The “cons” are that if recognised separately it will still need to be considered together with liability for onerous contracts testing, the pattern of release should still be linked with service provided and have no impact on the net result but with the added cost of reporting the associated amortisation expense.

Some Board members felt that the amortisation should be different from the earning of the residual margin and a straight line over the coverage term should be required while others felt that it should always be done in the same manner as the earning of the residual margin.

This was an educational session so no decisions were taken. However the Board members indicated to the staff by a majority of 9 votes that they would prefer to explore treating acquisition costs in a way that they do not result in incurred expense at initial recognition and that are taken to income with a pattern of release yet to be determined but that would avoid the recognition of revenue upfront. This conclusion seems to suggest that the final debate would be to finalise the choice between options 2 and 3 as presented above.

The IASB discussed the interaction of the investment entity proposals with IAS 28. The exposure draft proposed to replace the current fair value option in IAS 28 available when ‘an associate or a joint venture is held by, or is held indirectly through, an entity that is a venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds’ with a requirement to measure an investment entities interests in associates or joint ventures at fair value through profit or loss.

Most constituents agreed with the requirement to use fair value for an investment entity’s interests in associates and joint ventures, but some noted that subsidiaries that provide services to the investment entity are consolidated and therefore suggested that associates or joint ventures that provide services should have the equity method of accounting applied rather than fair value. However, a majority of constituents disagreed with removing the fair value option available in IAS 28 as many entities that may not meet the definition of an investment entity currently avail themselves of this option.

Based on the constituent feedback, the IASB tentatively decided to require investment entities to measure their investments in associates and joint ventures providing services to the investment entity using the equity method of accounting and all other investments in associates and joint ventures at fair value through profit or loss. The IASB also tentatively decided to retain the fair value option in IAS 28 for venture capital organisations, mutual funds, unit trusts, investment-linked insurance funds and similar entities that are not investment entities.

Previously, the Board had stated that it planned to undertake an initial comprehensive review of the IFRS for SMEs (International Financial Reporting Standard for Small and Medium-sized Entities) to assess the first two years’ of experience that entities have had in applying the IFRS for SMEs. During this review process, the Board intends to consider new and amended IFRSs that have been adopted since the IFRS for SMEs was issued and whether any amendments should be proposed to address any implementation issues identified in the comprehensive review.

At the June meeting, the Board tentatively approved the staff’s request to issue for public comment an Invitation to Comment (later retitled as a Request for Information) (which is the first step in the process) on the comprehensive review of the IFRS for SMEs with a proposed comment deadline of 30 November 2012. The objective of the document is to seek the public’s views on whether there is a need to make any amendments to the IFRSs for SMEs and, if so, what amendments should be made and to ensure constituents to raise their own issues. The document involves an optional response document that the constituents could use for submitting their comments. The document does not contain any preliminary views of the IASB or the SME Implementation Group (SMEIG). One of the Board members suggested adding a question on how long each entity had been applying the IFRS for SMEs to obtain more data about the prevalence and usage of IFRS for SMEs.