This session was initially scheduled to be a joint session with FASB to reach joint tentative decisions on the papers presented. However following the discussion of the same set of papers in a FASB-only education session on 18 January the agenda has been amended and this session was demoted to an IASB-only education session.

The agenda included the following items:

• The Board's progress on the project so far
• Agenda paper 2A: Premium Allocation Approach (PAA) eligibility criteria
• Agenda paper 2B: PAA Mechanics

The Board was not asked to make any decisions at this point.

The Staff noted that the IASB has substantially completed the work needed relating to the measurement of an insurance contract and that several decisions are in line with the FASB. However there are some areas where the Boards have reached different conclusions and in the coming months whilst completing discussions on the remaining topics the Board will assess whether any differences between them can be reconciled prior to the publication of the respective due process documents.

Premium Allocation Approach (PAA) – Eligibility criteria (Paper 2A)

The IASB discussed some proposed principles-based eligibility criteria for the premium allocation approach. The proposals suggested that insurers should apply the building block approach rather than the premium allocation approach if, at the contract inception date, either of the following conditions is met:

• It is likely that, during the period before a claim is incurred, there will be a significant change in the expectations of the net cash flows required to fulfil the contract that would not be captured by the onerous contract test ('expected cash flows criterion'); or
• Significant judgement is required to determine the amount of premium to be recognised in each reporting period, for example if there is significant uncertainty about the length of the coverage period ('allocation of premium criterion').

The Staff noted that the Boards have discussed the eligibility criteria on previous occasions and at most recent in October meeting. Paper 2A proposes principles-based eligibility criteria for the PAA that were developed from that October meeting. The Staff reported that it had done targeted outreach and contract "testing", noting that when participants had reached different conclusions on the eligibility of certain contracts, this was the result of subjectivity and judgment needed. They also noted that only a relatively small set of different circumstances produced different conclusions.

Extensive debate ensued with IASB members appearing in agreement with the intent but noted that it was overly complex and did not address the issue of whether PAA is a proxy or a separate model. It was noted that this was the 4th time the Boards were discussing this item and, at least, there continues to be agreement on the big picture. In general, the IASB members noted their belief that there is one model for insurance contracts, and that default is the Building Blocks Approach (BBA). The PAA is merely a proxy or practical expedient to applying the full BBA. In terms of what qualifies a contract to utilise the PAA, almost everyone agreed that a 12 month duration test is a good practical expedient. The remaining question is the need to develop additional application guidance to determine which contracts longer than 12 months falls into the PAA.

The Staff indicated they would bring the PAA criteria back in February, inclusive of a supplement to Paper 2A to have a 12 month practical expedient, and then criteria that would address the issue: "would the PAA serve a high quality proxy for the BBA". The IASB Chair noted this will be the fifth time this subject is discussed.

Premium Allocation Approach (PAA) – Mechanics (Paper 2B)

The Staff introduced Paper 2B and whether the PAA proposed in the ED could be simplified by considering (a) the requirement to discount the liability for remaining coverage and accrete interest, and (b) the treatment of acquisition costs.

The Staff highlighted the advantages of alignment with the revenue recognition ED and disadvantages of being operationally difficult. The Staff proposed the following two alternatives:

• Alternative A: Do the Boards agree that the measurement of the liability for remaining coverage should not be discounted and interest should not be accreted on the liability?
• Alternative B: Do the Boards agree that: (1) Discounting and interest accretion should be required in the measurement of the liability for remaining coverage for contracts that have a significant financing component? And, (2) as a practical expedient, insurers need not apply discounting (or interest accretion) if the coverage period of the contracts is less than one year?

Generally the discussions seemed to favour the view that discounting and interest accretion should be required in the measurement of the liability for contracts' remaining coverage when a significant financing component is present (this is consistent with the proposals in the revenue recognition ED).

As part of the discussions on mechanical issues, the IASB also discussed the treatment of acquisition cost.

The Staff noted that some believe that the measurement of acquisition costs in the PAA should include directly attributable costs and that insurers should be permitted to expense directly attributable costs that are not incremental. However, others believe that the measurement of acquisition costs in the PAA should be consistent with the proposals in the revenue recognition ED (i.e. only incremental costs will not be expensed as incurred). Finally, the Staff noted that acquisition costs should be recognised as an asset and should be amortised in a manner consistent with the tentative decision on reducing the liability for the remaining coverage.

The outcome of the discussion was a desire to maintain an alignment between BBA and PAA. Ultimately, almost everyone agreed that acquisition costs are part of the cash flows of the insurance contract and do not represent a separate asset.

The Board continued its discussions on development of a macro hedge accounting model. At the November 2011 Board meeting, the staff introduced eleven steps that will be considered for alternatives in the valuation of the risk position in a macro hedge accounting model.

The January discussion focused on the following steps:

• Step 4: Portfolio as unit of account
• Step 5: Open portfolios to be included
• Step 6: Applying repricing risk for periods rather than days.

The staff presented the Board with agenda papers using the example of hedging interest rate risk. These papers focused on risk management approaches based on expected behaviour of a portfolio using 1) portfolios as units of account for hedge accounting purposes and 2) bottom layer approaches. One of the papers walked through these approaches using a closed portfolio as an example with the second paper overlaying application to an open portfolio and the additional considerations introduced with a constantly shifting portfolio. The staff did not ask the Board to make any decisions during this meeting.

The papers laid out three potential alternatives and the implications for each. The first alternative is the portfolio fair value hedge of interest rate risk under IAS 39. The second alternative is a portfolio valuation approach attributable to the hedged risk on the basis of the net position with a constant hedged proportion. This approach would allow designation of the portfolio as the unit of account and therefor the ongoing valuation of the portfolio for purposes of hedge accounting. The third alternative is a bottom layer approach to reflect the net risk position (e.g., a layer of a gross position that represents the net risk).

The staff analysis for the alternative of applying existing IAS 39 highlighted the problems and limitations that currently exist. Over hedging the net risk position (from a risk management perspective) is not visible to the extent the hedging instruments are covered by the gross position designated for hedge accounting purposes. Similarly, under hedging the net risk position is also not visible. Prepayment risk of the net position is only partly visible in that a release of the hedge adjustment is dependent on the hedge proportion and the designated hedged items out of the net risk position. The ineffectiveness of the hedging relationship is also only partly visible based on the hedged proportion and the designated hedged items out of the net risk position. Perhaps most importantly, application of the IAS 39 approach is operationally complex requiring tracking of the hedge adjustment based on changes in hedged proportions, frequent re-designations and 'late hedges'.

The staff analysis for the portfolio valuation approach highlighted that this approach provides visibility in to both over and under hedging the net risk position as the entire hedged portfolio (both assets and liabilities) would be remeasured and therefore increases or decreases in the net position would give rise to ineffectiveness. Additionally, it provides visibility of prepayment risk as each prepayment triggers a release of the related hedge adjustment. This approach also provides visibility to the hedge ineffectiveness. The staff also highlighted that the portfolio valuation approach does not require tracking of hedge adjustments due to a uniform hedged proportion for all items (rather than a proportion) and immediate consideration of changes to the portfolio resulting in no late hedges. They noted that the complexity will depend on the level of synergies with the valuation approaches applied by risk management.

The staff analysis for the bottom layer approach highlighted that it does not provide visibility in to over or under hedging. It also does not provide visibility of prepayment risk if the risk does not lead to a decrease or breach of the designated layer. Visibility of hedge ineffectiveness would be dependent on the flexibility regarding the definition of layers. The staff noted this approach would be the most simple approach so long as the layer does not change, but changes to the designated layer leads to similar tracking issues as hedge accounting but at a portfolio level.

Most of the Board members expressed general support for the portfolio valuation approach based on the staff analysis as it provides the most transparency. One Board member felt the papers did not adequately address the interdependence between interest rate risk and behavioural factors (such as prepayments). Another Board member highlighted the importance of appropriate disclosure for these hedging relationships. One Board member asked the staff if the portfolio valuation approach was consistent with how risk managers currently managing risk citing concerns the accounting approach could instead drive risk management. The staff responded that this approach is the most common approach used by risk managers; however one Board member questioned this noting that some financial institutions focus on the matching of cash flows and are not fair valuing demand deposits and suggested the staff conduct outreach to ensure this approach was operational before proceeding too far down this path.

The Board made no tentative decisions during this session. The staff noted the Board's initial preference towards a portfolio valuation approach and will continue to proceed through the remaining five steps using that approach as a basis for further development.

Following the receipt of an unsolicited letter from the European Financial Reporting Advisory Group (EFRAG) formally requesting the extension of the effective date of IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosure of Interests in Other Entities, IAS 27 Separate Financial Statements (revised 2011) and IAS 28 Interests in Associates and Joint Ventures (revised 2011) (collectively, "the package of five"), the IASB considered a possible deferral of the package of five.

Reasons for the potential deferral of the package of five, as communicated in EFRAG's letter and other IASB staff analysis, included:

• European constituent concerns to EFRAG that the published effective date of the package of five would not provide sufficient time for full implementation.
• Two outstanding exposure drafts providing potential amendment to IFRS 10 have not been finalised; Amendments to the Transition Guidance in IFRS 10 (which provides only clarifications to the transition guidance to ease implementation requirements, and therefore, was not seen to be a significant burden in the application of IFRS 10) and Investment Entities. EFRAG noted that these exposure drafts introduce uncertainty into the requirements of IFRS 10 and could involve unnecessary efforts if the changes introduced by the exposure drafts conflict with the current interpretation and implementation of IFRS 10.

As a result of this analysis, the staff presented three possible approaches to the Board:

• retain the effective date for the package of five as annual periods beginning on or after 1 January 2013;
• retain the effective date for IFRS 12 as 1 January 2013 but defer the effective date for the other four standards to annual periods beginning on or after 1 January 2014; or
• defer the effective date for the package of five to annual periods beginning on or after 1 January 2014.

Many Board members expressed significant reservation with deferring the effective date of the package of five. Reasons expressed for this reservation included:

• IFRS 10 and IFRS 12 were published in response to the financial crisis and contain improvements to financial reporting that were requested by the G20 and the Financial Stability Board. Thus, timely adoption was seen as necessary and important.
• Many countries have already endorsed the package of five and expressed no significant concerns to the Board.
• Retaining the effective date would limit the potential for non-comparability that would result from having an extended period of optional application of the package of five.
• The 19 months between the May 2011 publication date of the package of five and January 2013 effective date represented a longer lead time than the IASB normally provides for new standard adoption.
• An adoption of IFRS 12 at 1 January 2013 with deferral of other standards in the package of five was not considered practical given that all of the new standards are interrelated.

One Board member, acknowledging the concerns of EFRAG related to currently outstanding exposure drafts impacting IFRS 10, proposed allowing a scope-specific deferral of IFRS 10 by those entities which are expected to be impacted by the Investment Entities exposure draft. However, other Board members expressed concern with this proposal, noting the difficulty in defining which entities would be subject to the deferral (e.g., is it based on the proposed investment entities definition or applying definitions set forth in IAS 28). Additionally, another Board member questioned whether the scope of the Investment Entities exposure draft would significantly impact application of IFRS 10, although acknowledging excess efforts may ensue. He noted the exposure draft's scope did not relate to the accounting for an investment entity, but rather, considered the recognition and measurement of investments made by an investment entity. Therefore, he did not believe the outstanding exposure draft should influence the effective date of the package of five.

With little additional debate, the Board tentatively decided to retain the effective date for the package of five as annual periods beginning on or after 1 January 2013.

The IASB staff presented feedback received in response to the Board's request for views Agenda Consultation 2011, as published for public comment in July 2011. Feedback was provided as an education session. No tentative decisions were taken by the Board.

In the conduct of this meeting, Board members provided very little feedback, but rather, limited their questions / comments to requesting clarification of information presented by the staff.

In summarising some of the key messages set forth by the staff, which was provided by way of 245 comment letter responses as well as investor-driven survey queries, the staff noted:

• Many respondents believed the Board should complete the four current projects (financial instruments, insurance contracts, leases and revenue recognition) as a priority.
• Many respondents believed the balance of efforts should be on maintaining IFRSs instead of developing IFRSs. This would include performing post-implementation reviews and providing implementation support processes, among other things.
• The conceptual framework was seen by many respondents as a priority, specifically in the areas of defining assets and liabilities, discussing other comprehensive income, discussing performance reporting and developing a disclosure framework. Investors, in particular, sought an agenda focused on minimising complexity in financial reporting which was discussed in the context of development of a disclosure framework.
• There were many requests for a 'period of calm'. This was seen as a way to assist jurisdictions that are first-time adopters of IFRSs by limiting changes, while also allowing other IFRS preparers time to evaluate and apply recently issued-standards. Feedback also suggested that a period of calm would allow the Board to focus its efforts on the four current projects and to make targeted improvements to existing IFRSs where necessary.
• Many respondents noted that the Board should devolve more of the maintenance of IFRS activities to the IFRS Interpretations Committee (IFRS IC) and the role of the IFRS IC should be redefined. Likewise, local standard-standards and regional groups were seen as resources to assist the IASB in research activities.
• While many respondents advocated a focus on framework projects (e.g., conceptual framework and presentation and disclosure framework), respondents did highlight certain standard-level projects of interest. The 6 projects that were most often cited by respondents as high priority included (1) other comprehensive income and performance reporting, (2) business combinations between entities under common control, (3) agriculture, particularly bearer biological assets (often jurisdictional specific response from Asian region), (4) rate-regulated activities (often jurisdictional specific response from Canada), (5) extractive activities and (6) emission trading schemes. However, many other project priorities were noted, including investor-specific priorities such as a discount rate project.

Acknowledging this feedback, the Board considered possible ways forward. Board suggestions included:

• Performing research. Many Board members requested that the staff perform limited research to scope the nature of prospective projects. Subsequent to identifying the scope of the issues, Board members requested that the staff consider cross-cutting issues to bifurcate projects (e.g., if the scope of Project A and Project B both relate to defining / identifying assets, these projects could be taken to the Board's agenda collectively).
• Searching for 'quick wins'. Many Board members were interested in identifying projects / issues which could be resolved quickly and were likely to yield little disagreement. These projects could potentially be added to the Board's agenda in the nearer term.
• Seeking input from the Advisory Council. The Board noted the need to present comment letter feedback to the Advisory Council to understand their reactions to the feedback received.
• Developing a proposal. Following the performance of the above, and considering any other offline feedback by Board members, Board members suggested that a proposal be brought before the Board for more thorough deliberations at a future meeting.

Board members generally expressed universal support for these suggestions.

The staff presented an analysis of the comment letters received on the Board's exposure draft Government Loans (Proposed amendment to IFRS 1) published in October 2011. The exposure draft includes a proposed amendment to amend IFRS 1 to provide the same relief to first-time adopters as the same prospective application provisions in certain IFRSs granted to existing preparers of IFRS financial statements.

The staff noted that 35 comments letters were received which were supportive of the proposed amendment. However, the respondents raised several comments on the following areas which the staff addressed:

• Scope of the proposed amendment — The staff proposed drafting revisions to limit the scope of the proposed exemption to matters of recognition and measurement such that a first-time adopter would be required to classify such a loan as a liability in accordance with IAS 32 Financial Instruments: Presentation, but would not be required to restate the carrying amount of the previous GAAP balance for the loan at the date of transition. This would provide the same relief as provided to existing preparers. The staff clarified that this relief should only apply to loans entered into prior to the transition to IFRS. The Board tentatively agreed with the staff's view that the amendment be limited to matters of recognition and measurement and asked the staff to consider during the drafting stage whether it was clear that the relief would apply to loans entered into prior to the transition to IFRS.
• Clarification on how to apply the exception after the date of transition — The Board tentatively agreed with the staff's view that its intention was to require an entity to apply IFRS 9 after transition date to a government loan at a below-market rate of interest entered into before the date of transition to IFRSs. To apply IFRS 9 after the date of transition, an entity should calculate the effective interest rate by comparing the carrying amount at the date of transition with the amount and timing of expected repayments to the government. The staff recommended drafting changes to clarify this point. The Board tentatively agreed to include an example as part of the implementation guidance. In addition, the Board asked the staff to include as part of the example, a situation where the government loan had previously been recorded in equity and had to be reclassified into a loan in accordance with IAS 32. One of the Board members questioned what amount should be attributed to this reclassification if this specific amount of equity had not been traced through historically. The Board tentatively agreed that this amount would be based on the amount originally received.
• Clarification on whether the option to apply IFRS 9 retrospectively is available on a loan-by-loan basis — The Board tentatively agreed with the staff's view that the exception should be available on a loan-by-loan basis for all government loans that originated prior to the date of transition and for which the required information to apply IFRS 9 was obtained at the relevant time and agreed to the staff's revised drafting.
• Optional exemption versus mandatory exception and Board's future consideration of IFRS 1 — The Board tentatively agreed that no changes to the amendment were required in respect of the other comments discussed.

The Board tentatively agreed that the staff should proceed with the proposed amendment including finalisation of drafting and a ballot to be provided to the Board with the view to issuing the amendment by mid-February 2012. The final amendment would be effective for reporting periods beginning on or after 1 January 2013, with early adoption permitted.

The staff provided the Board with a summary of the issues discussed at the previous IFRS Interpretations Committee meetings.

In particular, the Board discussed the following topics:

• IFRS 3 Business Combinations — identification of the acquirer and common control transactions (Agenda paper 7A).
  • The IFRS Interpretations Committee ('the Committee') received two submissions requesting guidance on the accounting treatment for two fact patterns that involved the formation of a new entity to facilitate the spinning-off of a business within a group under IFRS 3 Business Combinations. The first submission requested guidance on the factors that are relevant when identifying an acquirer in a business combination while the second submission requested guidance on the accounting for common control transactions and included a request to clarify whether a business that is not a legal entity could be considered the acquirer in a reverse acquisition under IFRS 3.
  • Based on the staff's analysis and assessment of the agenda criteria, the Committee felt that the accounting for fact patterns involving the creation of a newly formed entity and the accounting for common control transactions were too broad to be addressed through an interpretation or through an annual improvement. As such, the Committee recommended to the Board that it should consider the specific fact patterns submitted in the context of a broader project on accounting for common control transactions, which the Board might address at a later stage. The Board discussed the issue and noted that this topic would be considered as part of its wider agenda consultation.
• IAS 7 Statement of Cash Flows — classification of cash payments for deferred and contingent considerations (Agenda paper 7B)
  • The Committee received a submission requesting guidance on the classification of cash payments for deferred and contingent considerations under IAS 37.
  • The majority of the Committee members determined that the issues raised by the submitter was too broad to be resolved through the annual improvement process and proposed that the Board should not add this issue to the Annual Improvements project. The staff noted that it had received many submissions on various issues relating to IAS 7. The Board asked the Committee to look at the issues relating to IAS 7 as a package and perform an analysis to determine if there were any common themes and to evaluate these and present their findings to the Board.
• IAS 7 Statement of Cash Flows — classification of cash flows for construction or upgrade services in a service concession arrangement
  • The Committee received a submission requesting clarification on the classification of cash flows for an operator in a service concession arrangement within the scope of IFRIC 12 Service Concession Arrangements.
  • The Committee recommended that the Board proceed with the proposed improvement to amend paragraph 14 of IAS 7 to include 'cash receipts and payments from construction or upgrade services related to service concession arrangements within the scope of IFRIC 12' within the list of examples of cash flows from operating activities. The Board decided not to make a decision at this point in time and as noted above, the Board asked the Committee to look at the issues relating to IAS 7 as a package and perform an analysis to determine if there were any common themes and to evaluate these and present their findings to the Board.

The IASB and FASB met to discuss their respective projects on classification and measurement of financial instruments. Late in 2011, the IASB had agreed to consider reopening IFRS 9 to address certain issues, one of which was the possibility for further convergence with US GAAP.  The FASB is also concluding re-deliberations on development of their classification and measurement project. The staffs decided to formally bring a question to the Boards of whether the Boards wanted to work on alignment between their respective classification and measurement models.

The staffs' proposal included consideration by the Boards of:

1. which instruments (e.g. what cash flow characteristics and business activities) are eligible for amortised cost measurement
2. the need and basis for bifurcating financial assets
3. the basis for, and scope of, a classification category of debt instruments measured at fair value through other comprehensive income ('FVTOCI')
4. knock-on effects from the above issues.

One of the IASB members mentioned his agreement with the staffs' proposal but suggested that a target date for completion be set so that the discussions did not further delay the implementation of IFRS 9. He also asked the staff whether recycling of amounts recognised in other comprehensive income would be part of the discussions around the FVTOCI category. The IASB staff affirmed that would be part of the discussion. Another Board member questioned if the Boards were to agree on a FVTOCI category for debt instruments but disagree on recycling of amounts in OCI whether it would be viewed as converged.

One IASB member stated that he hoped both Boards could come to the same position rather than attempting to minimise differences. He also suggested that the staff should include analysis in their agenda papers of user views on benefits suggesting that the Boards should not fail to resolve their differences because of personal preferences but genuinely considering users' needs.

One IASB member raised the issue of the potential for a cost exemption for unquoted equity instruments. The Board had previously decided not to include this as part of the reconsideration of IFRS 9 but rather attempt to address some of the concerns through IFRS 13 educational materials. Another IASB member noted the FASB had provided a scope out for non-public entities so that perhaps this issue should be included in the convergence discussions. However, the IASB Chair had little interest in revisiting the previous decision not to include this issue as part of the IFRS 9 reconsideration.

Ultimately, both Boards agreed to work together to improve the alignment of their respective financial instrument classification and measurement standards.

The IASB and FASB continued their discussions on the development of the three bucket impairment model. As part of the development of the Supplementary Document (‘SD’) issued in January 2011, the Boards had tentatively decided in March and April 2011 that purchased financial assets where there was no explicit expectation of credit losses would be assessed for impairment under the SD approach (similar for originated financial assets) while purchased financial asset with an explicit expectation of loss (e.g. those purchased at a deep discount due to credit deterioration) would recognise interest income based on expected cash flows rather than contractual cash flows. However, given the significant differences in the impairment model under the three bucket approach and the good book/bad book approach in the SD, the staffs wanted the Boards to revisit their previous decisions on purchased financial assets.

Application of the general impairment model to financial assets with an explicit expectation of losses at acquisition

The Boards considered whether, for purchased financial assets that have been designated for income recognition using expected cash flows, changes in initial expectations should be based on a bucket one measurement (e.g., changes in the next 12 months) or on a bucket two/three measurement (e.g., changes in lifetime expected losses). The result of this decision would determine whether these purchased assets would initially be classified in bucket one or in bucket two or three for future impairment considerations. While initially classifying these loans in buckets two or three could be viewed as inconsistent with the overall three bucket impairment model (which would begin all assets in bucket one with transfers based on deterioration of credit quality), such an approach still follows a deterioration notion as no impairment expense is recognised upon acquisition, rather impairment is only recognised upon changes in initial expectations. Based on this rational, the IASB and FASB tentatively decided that purchased financial assets with an explicit expectation of losses should be initially classified in buckets two or three and recognise an impairment allowance based on the changes in lifetime expected cash flows since acquisition.

Scope

The Boards then discussed the scope for which purchased financial assets it is appropriate to recognise interest income based on an initial expectation of cash flows at the time of acquisition and what level of aggregation should be used in that assessment.

Both existing IFRS and US GAAP include similar concepts for purchased financial assets that have experienced credit deterioration since origination. IAS 39 describes the scope of such instruments as those ‘acquired at a deep discount that reflects incurred credit losses’. US GAAP’s ASC 310-30 applies to financial assets with ‘evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable’. During the March and April 2011 discussions on purchased financial assets the Boards had used the phrase ‘purchased financial assets where an explicit expectation of losses exists [when analysed at the individual asset level]’.

The discussion began with the IASB Chair asking the staffs if there was a possibility of marrying the two existing scope criteria. The IASB staff noted that the existing scopes in IFRS and US GAAP are based on an incurred loss model and use in an expected loss impairment model may not be as easily transferable as thought.

The IASB Board members, with minor exceptions, were broadly in favour of keeping the scope fairly narrow by using language similar to ‘explicit expectation of losses’ as they believed this would be interpreted similar to the ‘acquired at a deep discount’. They noted the operational concerns of the original IASB ED which required an expected cash flow interest income recognition model and therefore wanted to ensure the population was not too broad to reintroduce those operational concerns. One IASB member did note a preference for ‘fine-tuning’ the existing scope definitions raising a concern over introduction of the term ‘explicit expectation of losses’ and its ultimate interpretation. Another IASB member preferred to make the division at purchased financial assets expressing concern over how to appropriately differentiate ‘deep discounts’ and other discounts. One IASB member mentioned the importance of appropriately defining unit of account and raised concerns over the possibility of creating arbitrage opportunities such that grouping a problem purchased loan with other performing purchased loans in order to bypass the scope.

However, certain FASB members preferred to use similar terminology as to the model for transferring originated assets to bucket two or three. They suggested that purchased assets would recognise interest income based on expected cash flows when there is a more than insignificant deterioration in credit quality since origination and the likelihood of default is such that it is at least reasonably possible that the contractual cash flows may not be recoverable. However, the IASB cautioned that such an approach could lead to scope much broader than intended and subject more financial assets to this income recognition model, reintroducing the operational concerns with the original IASB exposure draft. The FASB Chair noted that she would prefer to get the scope right and then address the accounting separately to see if modifications could address those operational concerns. However the IASB was highly sceptical of such an approach noting they’ve been working for several years in attempting to address those operational challenges and the time proportional approach in the SD was their best effort at addressing those concerns which was rejected by constituents.

The Boards made no decision on scope of purchased assets subject to an income recognition model based on expected cash flows.

Changes in expectations subsequent to acquisition

Under the model for purchased financial assets with credit deterioration, where interest income is recognised on expected cash flows and impairment is based on credit deterioration subsequent to acquisition, the issue of improvements in credit quality must be considered. The Boards considered whether the original effective interest rate (‘EIR’) based on expected cash flows should be ‘unlocked’ and adjusted for improved expectations or whether reversals of impairment charges or gains should be recognised immediately in profit or loss. Under current US GAAP, the EIR is adjusted for favourable changes in expectations while under IFRS, for fixed rate assets the EIR is locked and any changes are recognised as changes in the impairment allowance.

The Boards were generally supportive of an approach where the initial EIR is locked and any favourable changes in expected cash flows is recognised as a ‘gain’ in profit or loss. One of the FASB members raised issue with classifying the favourable changes in a separate line item from the impairment loss.  Rather, he requested both favourable and unfavourable changes in expected cash flows should be recognised in the same line item (i.e., impairment loss). The FASB members agreed with this modification; the IASB members were originally not supportive preferring recognition as a gain rather than distorting the impairment loss amount. However, for convergence the IASB also tentatively decided that increases in cash flows expected to be collected are recognised immediately in profit and loss as a reduction of the impairment loss.

Presentation of purchased financial assets with an explicit expectation of losses

Under IFRS 3(R) and FAS 141(R), purchased financial assets are recognised at their acquired fair value without any carryover of allowance for uncollectibility. FASB constituents in particular have raised the issue of the differing balance sheet presentation methods for originated and acquired financial assets and the issues raised in financial statement analysis (as originated loans have an associated allowance while purchased loans are recognised at fair value with no associated allowance balance).

One IASB member stated his preference for net presentation (e.g., no associated allowance for purchased loans) as in his view it was not relevant to disclose losses incurred by someone else. However, he did note that appropriate disclosure was needed for comparability between originated and purchased assets. Another IASB member emphasised what a difficult issue this was as recognising purchased loans at fair value without a corresponding allowance balance does impact analysis for financial institutions. However, she also mentioned that presenting purchased assets on a gross basis would also impact other analysis so there wasn’t a clear and simple solution. Other IASB members raised the issue of other asset classes that are acquired under business combination accounting and that there are similar implications for property, plant and equipment and other assets that are recognised at fair value without carryover of accumulated depreciation. The IASB unanimously supported requiring net presentation for purchased financial assets. The FASB had slightly different views with several of their Board members stating initial preferences for gross presentation. However, they noted that for convergence they could also support a net presentation if sufficient information were disclosed about the gross amounts. The Boards tentatively decided to require net presentation for purchased financial assets but would develop disclosures as part of the impairment disclosure package to provide transparency on the gross amounts of purchased financial assets.