Financial Instruments with Characteristics of Equity - Joint Meeting with the FASB
Staff presented a preliminary analysis disaggregating the total changes in the fair value of financial liabilities with the characteristics of equity between recurring and non-recurring changes using the cost of capital method. By this method, the total change in the fair value, which is perceived to have little informative value, is disaggregated into a more informative 'flow' amount representing interest change and the remaining part of the change in the fair value, which represents a value effect with little predictive value.
Several members of both Boards seemed to be concerned that when liabilities with characteristics of equity are measured at fair value as proposed, net income and earnings per share will be distorted by the wealth effect (effect of future expected cash flows) that has little correlation with performance.
Other members challenged the staff, noting that, in their opinion, the disaggregation had little value and seems to contain relatively complex calculations. The staff responded that users demanded classical interest charge on more complex and hybrid instruments (such as zero coupon convertible bonds). Another Board member stated that he had the impression that, given complexity of the calculation and presentation, perhaps the Boards could revisit the measurement basis as such. He proposed that the invitiation to comment in the exposure draft ask whether respondents ageeed with fair value measurement if the consequence is this type of disaggregation of fair value measurement.
A Board member was concerned about the lack of comparability and consistency with the general financial instruments project. He proposed that the same disaggregation criteria for all financial instruments. One FASB member noted that the FASB considered disaggregation of the changes in the fair value of financial assets into a credit risk part and remaining part and supported application also for financial liabilities in general. Several Boards members challenged applicability of such approach to derivatives.
One IASB member noted that in his opinion disaggregation in the statement of comprehensive income is not appropriate, and disclosing in the notes is most appropriate. In his view, the staff has tried to bring precision in a component of financial statements that is imprecise in nature. Another Board member responded that users are aware of the imprecise nature of the calculation but want the magnitude and direction of the change reported in the financial statements.
Overall the Board sensed that the proposed model is too complex and directed the staff to develop a simplified model of disaggregation of fair value changes on financial instruments with characteristics of equity.