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Financial Instruments - Derecognition Research Project

Date recorded:

The objective of this session was to obtain the views of the Board as to when financial assets and financial liabilities should be presented linked in the financial statements (referred to as 'linked presentation'). Any views of the Boards will be included in the staff report on derecognition, which is the next milestone in the research project on derecognition. This is an outcome of the papers presented at the Joint IASB-FASB Board Meeting in October 2007.

Staff presented two possible views on linked presentation - the joint presentation of financial assets and financial liabilities in primary financial statements (but still presenting them separately, that is, no netting).

The Board was presented a paper on two possible views when linked presentation is triggered:

View 1 - an entity shall apply linked presentation in the financial statements when either:

(a) An entity's obligation to a financial liability is satisfied solely by economic benefits generated by a financial asset. In this case the total liability is linked to the asset.

(b) An entity is obliged to pay a financial liability all economic benefits generated by a financial asset. In this case the total asset is linked to the liability.

(c) If a financial liability is satisfied solely by economic benefits generated by a financial asset (thus satisfying condition a.), and the entity is also obliged to pay all economic benefits on a financial asset to settle a financial liability (and also satisfies condition b.), then the financial liability is linked to the financial asset in accordance with condition a.

View 2 - an entity shall apply linked presentation in the financial statements when either:

(a) An entity is obliged at the reporting date to settle a financial liability using economic benefits generated by a financial asset. In this case it is the specific obligation to settle the liability using economic benefits generated by the financial asset that is linked to the financial asset, and other obligations of the entity to the debt holder will not qualify for linked presentation.

(b) An entity has a right at the reporting date to receive economic benefits on a financial asset equal to some or all of the economic resources to be sacrificed if a financial liability is settled. In this case it is the specific right to receive economic benefits equal to some or all of the economic resources to be sacrificed if the financial liability is settled that is linked to the financial liability, and other rights of the entity to receive economic benefits will not qualify for linked presentation.

These views do not only define when linked presentation is required but also if the liability is linked to the asset or vice versa.

The staff presented to the Board a set of scenarios to explain the similarities and especially the differences between both approaches, which can be summarized as follow (the complete case study can be downloaded as Agenda Paper 9B from the IASB's website):

View 1

View 2

1

80% Loan participation

Liability is linked to asset

Liability is linked to asset

2

80% Loan participation with a guarantee

No linked presentation

Liability is linked to asset

3

100% Loan participation with a guarantee

Asset is linked to liability

Liability is linked to asset

4

In-substance loan defeasance

No linked presentation

Asset is linked to liability

5

Pledged trade receivables

No linked presentation

No linked presentation

Only the first three scenarios were discussed. The Board had a lengthy discussion on the views and their application to the scenarios.

Some Board members expressed concerns that these scenarios might not be realistic. One Board member questioned whether this issue could better be dealt with in the project on financial statement presentation to avoid proposing principles that are not in line with what has already been agreed on. The staff noted that all discussions are currently at staff paper level.

As the staff talked the Board through the scenarios, some Board members had problems in arriving at the solutions the staff presented when applying the principles set out in views 1 and 2. Those Board members also could not extract the rationale behind the principles. They suggested that if some Board members cannot understand the principle then it is not a good idea to further elaborate on linkage.

On inquiry, the staff stated that the paper is based on the assumption that all financial items concerned are measured at fair value and that even if the cash flows of the linked items are identical in amount and timing there might be a gap due to the different risk premiums.

Also Board members could not see the rationale behind the analysis in scenario 3 that in view 1 the asset is linked to the liability while according to view 2 the liability is linked to the asset.

At one point in the discussion, one Board member raised the question if the staff could come back and make clearer how linked presentation enhances financial reporting, that would be an improvement in the staff paper. Others doubted that it would be desirable to add linkage in any outcome of the research project on derecognition. Another Board member suggested while linked presentation might not be desirable in the primary financial statements, users may find such information useful if it is disclosed in the notes. Board members also noted that linked presentation might mitigate some of the burden resulting from setting a high hurdle for derecognition.

No decisions were made.

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