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The IASB and FASB held a supplemental joint Board Meeting on 31 May-2 June 2011 to discuss numerous topics, including insurance contracts, financial instruments, revenue recognition and leases. The IASB met in London, with a few Board members joining remotely, while the FASB joined via teleconference from Norwalk, CT for joint discussion topics.
Agenda for the meeting
Tuesday, 31 May 2011
IASB/FASB joint meeting (12:00—16:00)
Insurance contracts - Reinsurance
Wednesday, 1 June 2011
IASB meeting (9:30-12:00)
Financial instruments - Hedge accounting
Macro hedge accounting — education session
IASB/FASB joint meeting (12:30-16:15)
Asset and liability offsetting
Thursday, 2 June 2011
IASB meeting (14:30-16:30)
Financial instruments - Hedge accounting
Financial statement presentation - Other comprehensive income
The FASB and IASB met for more than two and a half hours to discuss the topic of reinsurance which was originally scheduled to be discussed on 16 May 2011.
Reinsurance (Paper 3A/69A)
The FASB and IASB met for more than two and a half hours to discuss the topic of reinsurance which was originally scheduled to be discussed on 16 May. A reinsurance contract is an insurance contract that an insurer purchases to transfer insurance risk to another insurance company. The paper presented eight staff recommendations which were mostly agreed upon by the Boards. The Staff recommendations were developed considering feedback received from constituents that more details are required on the subject of reinsurance than what was included in the Exposure Draft / Discussion Paper (ED/DP).
Definition of significant risk transfer
The first Staff's recommendation was to add new application guidance to the significant risk transfer test. The guidance states that a reinsurance contract is deemed to meet the definition: "If substantially all of the insurance risk relating to the reinsured portions of the underlying insurance contracts has been assumed by the reinsurer".
Board members from both the IASB and FASB were uncomfortable with the words "substantially all" and, although they tentatively agreed with the principle behind the new guidance, they asked the Staff to refine the wording. Some Board members suggested using similar wording to those in paragraph 35 of the paper - "if the economic benefit to the reinsurer for its respective portion of the underlying policies is virtually the same as the ceding company's economic benefit, then the reinsurer has assumed substantially all the insurance risk related to the reinsurer policies". The Staff also explained that the guidance is effectively a short cut, and that if the "substantially all" condition is not met, the reinsurer would have to perform the full significant risk transfer test.
Both Boards tentatively agreed with the Staff's recommendation, assuming the wording is changed in line with that in paragraph 35 of the paper.
The second proposal from the Staff is for the guidance to be clarified such that an "insurer shall assess the significance of insurance risk contract by contract and that, contracts entered into simultaneously with a single counterparty for the same risk, or contracts that are otherwise interdependent, shall be considered a single contract". Both Boards tentatively agreed with the Staff's recommendation without much debate.
Recognition of reinsurance contract
The Staff recommended that "when the amount recoverable from the reinsurer for a loss on an underlying insurance contract is independent of the losses and recoverable on other underlying insurance contracts, the cedant should recognise a reinsurance asset when the underlying contract is recognised, otherwise the cedant should recognise a reinsurance asset when the reinsurance coverage begins". Although the Boards tentatively agreed with the principle proposed, they asked the Staff to clarify the wording as many found it confusing. The Staff clarified that this guidance should deal with non-coterminous contract covers when the reinsurance contract reinsures a class of insurance contract which may include also contracts that will be issued in future. In these cases if the reinsurance policy is on an aggregate loss basis, a reinsurance asset would be recognised at the effective date of the reinsurance policy. The reinsurance asset would be remeasured to take into account the new reinsurance contracts issued when they are initially recognised.
Ceded risk adjustment
The Staff recommendation is for the "ceded portion of the risk adjustment to represent the risk being removed from the use of reinsurance". In the Staff view, an insurer should arrive at the same answer whether it calculates the ceded risk adjustment based on the gross or net basis and it does not propose to specify the method that should be used to calculate it. The IASB tentatively agreed with the recommendation. The FASB did not discuss this topic given their preference for a composite margin.
Treatment of gains and losses
The Staff recommended a significant change from the ED/DP approach proposing that gains on purchase of reinsurance contracts are not recognised on day one. FASB unanimously supported this recommendation whilst a minority of four members of IASB out of the fifteen present voted against it.
The basis for this approach is that the cedant has not been relieved of the obligation it has reinsured (i.e. the reinsurance does not cause derecognition of the insurance liability) and that it could cancel or commute the reinsurance contract at a later stage. For these reasons, the measurement of the reinsurance assets using the building block approach noted above is reduced by any positive difference from that calculation. In other words, the initial recognition of the reinsurance assets is not greater than any upfront premium paid to the reinsurer to purchase the contract. Both Boards approved this change from the ED/DP and asked to include in the final IFRS that an additional reason to not allow the cedant to recognise a gain on reinsurance purchased is the subjectivity in the measure and the ultimate obligation the cedant has reinsured.
The Staff also recommended a change to the ED/DP when reinsurance protection is purchased by the cedant at a loss on day one (i.e. the building block calculation produces a net negative probability weighted present value inclusive of a risk adjustment asset). The Staff proposed that the ED/DP approach that when the reinsurance contract covers pre-claims liabilities a loss should not be taken to profit or loss immediately and it should instead be amortised over the coverage period as a component of the reinsurance asset. However, this treatment would not be permitted for reinsurance of post-claims liabilities (e.g. retrospective reinsurance) where a negative building block net result would have to be recognised immediately through profit or loss.
Although the FASB members found the language used unclear and over-complicated, they generally agreed with the Staff's recommendation. A very large minority of seven out of fifteen IASB members voted against deferring the loss over the coverage period and expressed a preference for immediate loss recognition also for reinsurance purchased to cover pre-claims liabilities.
Cession of residual / composite margin on underlying insurance contracts
The Staff proposal was that on initial recognition of the reinsurance contract the "cedant shall estimate the present value of the fulfilment cash flow for the reinsurance contract, including the ceded premium and without reference to the residual/composite margin on the underlying contracts, in the same manner as the corresponding part of the present value of the fulfilment cash flows for the underlying insurance contracts". Although one IASB member disagreed, both Boards tentatively agreed with this recommendation without much debate.
The Staff recommended that the "ceding commissions and expense allowances from the reinsurance contract be included in the expected cash flows of the measurement of the liability to the extent that the cedant has included their direct costs in the expected cash flows. Any excess amount should be recorded as a reduction in the ceded premium." There was confusion among Board members on this topic as it was not clear to them whether this was a question of measurement or presentation. The Staff clarified this is related to presentation and the Boards asked the Staff to bring back this discussion when they address presentation in a wider context.
Credit risk of reinsurer
The recommendation from the Staff was that "the cedant record an allowance for the risk of non performance by the reinsurer when estimating the present value of the fulfilment cash flows when the current information and events suggest the cedant will be unable to collect all amounts due according to the contractual terms of the reinsurance contract." The FASB were unanimously in favour of the Staff's recommendation. The IASB on the other hand preferred to rely on the general impairment model that is available in the current literature in IAS 39. This will be reviewed in light of the new impairment model for financial assets once it is finalised.
The IASB and FASB considered the impacts of the revenue project on how an entity should account for the costs of products manufactured for delivery under long-term production programs
Costs of products manufactured for delivery under long-term production programs
The staff have received recent questions about the effect, if any, of the revenue project on how an entity should account for the costs of products manufactured for delivery under long-term production programs. Those questions have been raised as part of the revenue project because accounting for production costs affects the profit margin an entity recognises upon fulfilment of a contract with a customer.
The staff noted that as part of the revenue recognition project, the Boards have developed a set of cost guidance, with a very limited scope, with the purpose of ensuring that the issuance of a final revenue standard does not create any gaps in existing standards as a result of the final standard replacing existing revenue standards that contain limited cost guidance. Hence, the Boards developed cost guidance in the revenue project for the following: (a) setup costs for services contracts, (b) precontract costs, and (c) inventory of a services provider. For other costs to fulfil a contract, an entity would apply other guidance such as existing standards on inventory, PP&E, and intangible assets. Production costs incurred under a long-term production program are not the types of costs for which the Boards developed cost guidance.
Several Board members suggested that they would prefer to have more consistency and expressed concern that there were diverse current practices in US GAAP and IFRSs when accounting for the costs of products manufactured for delivery under long-term production programs.
The Boards tentatively agreed that the accounting for costs of products manufactured for delivery under long-term production programs (transferred to a customer at a point in time) is not in the scope of the revenue project and that these costs relate to accounting for inventory and intangible assets.
The Boards tentatively decided that these topics should be addressed either at a later time or as part of a separate project.
At the meetings in June, the Boards intend to consider: (a) application of the revenue model to the telecommunications industry, (b) transition, and (c) whether re-exposure is necessary.
The IASB held an education session on the macro hedge accounting project.
Macro hedge accounting — education session
The IASB held an education session on the macro hedge accounting project.
The Board hosted presentations from Toronto Dominion Bank Group (TD Bank) and the European Banking Federation, including representatives from the French Banking Association, Rabobank, BNP Paribas, Intensa Sanpoalo, Commerzbank and HSBC. Both presentations focused on approaches financial institutions utilise to manage risks across the organisation for dynamic portfolios of financial assets and financial liabilities. No decisions were made as part of the education session.
The IASB and FASB hosted an educational session where members of the International Swaps and Derivatives Association (ISDA), followed by a joint meeting where the Boards discussed the unit of account for offsetting and collateral arrangements.
Education session with representatives of ISDA
The IASB and FASB hosted an educational session where members of the International Swaps and Derivatives Association (ISDA) and members of clearinghouses presented on the topic of collateral and the forms of collateral posting and settlements that occur through various clearing houses as well as through OTC contracts. No decisions were made as part of the education session.
The educational sessions was followed by a joint meeting where the Boards discussed the unit of account for offsetting and collateral arrangements.
Unit of account
Constituents have raised questions on the unit of account for applying the offsetting proposals in the exposure draft as the exposure draft did not specify unit of account guidance. The staff noted that this issue was of particular importance for the utility industry. Constituents have raised several ways in which the guidance in the exposure draft could be applied including:
To a portfolio of financial assets and financial liabilities (when each of the instruments comprise a single cash flow)
To identifiable cash flows of financial assets and liabilities (a portion of a financial asset and a portion of a financial liability)
To individual financial asset and financial liabilities (i.e., offsetting a portion of a financial asset against an entire financial liability and vice versa)
To a portfolio of financial instruments (each comprising of multiple cash flows) with coinciding payment dates
To a portfolio of financial assets and financial liabilities when the instruments consist of multiple cash flows (without a variation margin system) and non coinciding payment dates
To a portfolio of financial assets and financial liabilities and the instruments consist of multiple cash flows (with a variation margin system) and non coinciding payment dates
To a portfolio of derivative financial assets and financial liabilities (under a master netting agreement).
Various Board members had differing views with how the offsetting criteria should be applied, some believing it should be at the financial instrument level with others feeling it should be at the individual cash flows level. However, those who believed that the individual cash flow level acknowledged that there may be operational difficulties in requiring application at this level. The Board made no decisions during this session, the staff acknowledged they would bring detailed papers to discuss the issue of individual cash flows vs. individual instruments and that portfolios would be considered separately.
The IASB staff introduced the various types of collateral and how they may or may not be eligible for offsetting under application of the exposure draft should the general prohibition of offsetting collateral be amended. The IASB staff mentioned that both initial margin and contribution to default margin were forms of conditional right settlement (i.e., collateral held to protect against counterparty default) whereas the variation margin may be a form of legal settlement and therefore potentially eligible for the offsetting criteria. The Boards made no decisions during this session; it was simply an introductory session to set the basis for future discussions.
The IASB and FASB deliberated on the following topics in relation to lessee accounting: (1) subsequent measurement and (2) residual value guarantees (RVGs).
As part of its continuing deliberations surrounding the Exposure Draft Leases (Leases ED), the Boards deliberated on the following topics:
Lessee accounting: subsequent measurement
Lessee accounting: residual value guarantees (RVGs)
The Boards made a number of tentative decisions during these deliberations, as follows:
Lessee accounting: subsequent measurement
Confirm changes in the liability to make lease payments as a result of foreign exchange differences would be recognised in profit or loss
Confirm the right-of-use asset would be evaluated for impairment in accordance with IAS 36Impairment of Assets (IFRSs only) or Topic 350 Intangibles — Goodwill and Other (US GAAP only)
Permit revaluation of the right-of-use asset in accordance with the principles of IAS 38Intangible Assets if a revaluation policy is applied to owned assets of the same class consistent with the proposed guidance in the ED (IFRSs only). For preparers following US GAAP, revaluation of the right-of-use asset is not permitted.
Residual value guarantees (RVGs)
Amounts expected to be payable under RVGs included in the measurement of the lessee's right-of-use asset would be amortised on a systematic basis (i.e., to reflect the pattern in which the economic benefits of the right-of-use asset are consumed or otherwise used up) from the date of commencement of the lease to the end of the lease term or over the useful life of the underlying asset, if shorter. If a pattern cannot be readily determined, a straight-line amortisation method would be used
Lessees should reassess amounts expected to be payable under RVGs when events or circumstances indicate that there is a significant change in the amounts expected to be payable under RVGs. Changes to the lessee's liability to make lease payments arising from current or prior periods would be recognised in profit or loss, while changes relating to future periods would be recognised as an adjustment to the right-of-use asset. The allocation for changes in estimates of RVGs would reflect the pattern in which the economic benefits of the right-of-use asset will be consumed or was consumed; however, if the pattern cannot be reliably determined, an entity would allocate changes in estimates of RVGs to future periods.
The Boards directed the staffs to research distinguishing characteristics between RVGs and variable lease payments (e.g., contingent rent) for discussion at a future meeting.
Lessee accounting: Subsequent measurement of foreign exchange differences
As the Leases ED did not provide specific guidance on how a lessee should account for the effects of foreign exchange relating to the measurement of a liability to make lease payments and a right-of-use asset, and following respondent feedback to the Leases ED which requested clarity as to whether the effects of subsequent changes in the exchange rate would require recognition in profit or loss, consistent with the principles of IAS 21The Effects of Changes in Foreign Exchange Rates and Topic 830 Foreign Currency Matters, or as a change in the carrying amount of the right-of-use asset, the Boards tentatively decided, with little deliberation, to confirm that changes in the liability to make lease payments as a result of foreign exchange differences would be recognised in profit or loss.
One IASB member expressed concern with reflection of foreign exchange differences relating to future periods in the current period profit and loss, as he preferred bifurcation of foreign exchange differences between those derived from current or prior periods and those relating to future periods (for reflection as a change in the carrying amount of the right-of-use asset). Other Board members, while not disputing the tentative decision, expressed concern with reflection of foreign exchange guidance within the leases standard. Specifically, certain Board members preferred that relevant guidance on foreign exchange activity be applied in the foreign exchange rate standards, which the staffs will consider in future standard drafting.
Lessee accounting: Impairment of a lessee's right-of-use asset
Considering that the impairment models in IFRSs and US GAAP are not currently converged, the Boards deliberated on the proposal in the Leases ED to follow the existing impairment models in IFRSs and US GAAP when assessing impairment of the right-of-use asset. The staffs presented outreach feedback which noted that many supporting impairing the right-of-use asset as proposed in the Leases ED, while others requested a converged solution. With little deliberation, the Boards acknowledged that retention of the proposals in the Leases ED would not result in a converged solution, but they noted that the consistency and comparability that would result in using the same impairment model for leased and owned assets would outweigh the disadvantage of divergence. Thus, the Boards confirmed the right-of-use asset would be evaluated for impairment in accordance with IAS 36Impairment of Assets (IFRSs only) or Topic 350 Intangibles — Goodwill and Other (US GAAP only).
Lessee accounting: Revaluation of a lessee's right-of-use asset (IASB-only)
As an IASB-only issue, given that for preparers following US GAAP, the Leases ED did not allow revaluation of the right-of-use asset, the Boards deliberated on the proposals in the Leases ED that:
revaluation of a lessee's right-of-use asset would be permitted if a lessee revalued all owned assets in the underlying asset's class of property, plant and equipment, but would not be required, even if the rest of the asset class was revalued
if a lessee revalues its right-of-use assets, it would be required to revalue the entire class of assets to which the underlying asset belongs
revaluation would be required to be performed in accordance with IAS 38Intangible Assets; however, an active market would not be required to revalue right-of-use assets.
The IASB staff noted that a minority of respondents to outreach expressed concern with the Board's proposals in the Leases ED, with some respondents expressing a desire for a converged solution to that of US GAAP and others requesting that right-of-use assets be treated as their own class for purposes of revaluation.
With little debate, the IASB tentatively decided to permit revaluation of the right-of-use asset in accordance with the principles of IAS 38Intangible Assets if a revaluation policy is applied to owned assets of the same class consistent with the proposed guidance in the ED. While this will not result in a converged solution, the Board previously decided that the consistency and comparability that would result in using the same revaluation model for leased and owned assets in IFRSs would outweigh the disadvantage of divergence with US GAAP. Likewise, the prohibition would be difficult to justify as the right-of-use asset is subject to existing guidance for amortisation and impairment, and existing IFRS guidance currently allows revaluation for non-financial assets.
Lessee accounting: Residual value guarantees
The Boards deliberated on subsequent measurement and reassessment of RVGs for lessees. With little debate, the Boards tentatively decided that amounts expected to be payable under RVGs included in the measurement of the lessee's right-of-use asset would be amortised on a systematic basis from the date of commencement of the lease to the end of the lease term or over the useful life of the underlying asset, if shorter. If a pattern cannot be readily determined, a straight-line amortisation method would be used.
Many Board members, however, expressed concern over how to distinguish RVGs and variable lease payments (e.g., contingent rent) in light of the Boards' previous tentative decision that variable lease payments should not be included in the measurement of a lessee's liability to make lease payments and a lessor's lease receivable unless the variable lease payments are 'disguised minimum lease payments'. While this question speaks more to the measurement of RVGs than to the amortisation, one Board member highlighted that RVGs may be derived from underlying asset usage (such as an automobile lease in which the RVG varies according to kilometres driven), and it was not clear whether this would be considered a RVG or a variable lease payment. Thus, the Boards directed the staffs to research distinguishing characteristics between RVGs and variable lease payments for discussion at a future meeting.
The Boards then considered the reassessment of RVGs following Leases ED proposals which noted that lessees should reassess the carrying amount of the liability to make lease payments arising from each lease if facts or circumstances indicate that there would be a significant change in the liability since the previous reporting period. The staffs, citing little respondent feedback on this issue other than practical application challenges from a cost-benefit perspective, proposed to retain the reassessment requirement in order to provide relevant and timely information to users of financial statements on expectations of the lessee's liability in conjunction with providing consistency with previous tentative decisions requiring reassessment of options.
The Boards tentatively decided that lessees should reassess amounts expected to be payable under RVGs when events or circumstances indicate that there is a significant change in the amounts expected to be payable under RVGs. The Boards tentatively decided not to include indicators, such as contract-based, asset-based or entity-based factors, in the final standard for purposes of defining whether reassessment should occur, but rather, proposed application of a general significant change threshold for application by preparers.
Finally, the Boards deliberated on accounting for changes in the expected amounts payable under a RVG as a result of reassessment, including retention of proposals in the Leases ED or requiring all changes be recognised in profit or loss. With little debate, the Boards decided that changes to the lessee's liability to make lease payments arising from current or prior periods would be recognised in profit or loss, while changes relating to future periods would be recognised as an adjustment to the right-of-use asset (consistent with Leases ED). The allocation for changes in estimates of RVGs would reflect the pattern in which the economic benefits of the right-of-use asset will be consumed or was consumed; however, if the pattern cannot be reliably determined, an entity would allocate changes in estimates of RVGs to future periods. Such a conclusion is based on assessment that the above decision better reflects the economics of many leases. One Board member, however, noted that the above decision was inconsistent with earlier tentative decisions on subsequent measurement of foreign exchange differences. Another Board member highlighted that the proposal for RVGs is consistent with decommissioning guidance, however.
The IASB and FASB debated the following topics as part of their redeliberations on the hedge accounting exposure draft: (1) rebalancing the hedging relationship (2) discontinuing the hedging relationship (3) options as hedging instruments (4) net written options.
Rebalancing the hedging relationship
The hedge accounting exposure draft introduced the concept of rebalancing a hedging relationship (i.e., reducing or increasing the quantities of the hedging instrument or the hedged item in order to maintain an appropriate hedge ratio). The exposure draft proposed requiring rebalancing the hedging relationship if the risk management objective has not changed but the hedging relationship would otherwise fail the effectiveness assessment. The exposure draft also permitted rebalancing when an entity anticipates that the current hedge ratio may cease to meet the effectiveness assessment in the future. The rebalancing concept was introduced to address issues under IAS 39Financial Instruments: Recognition and Measurement where dedesignation and redesignation of a new hedge is required in order to adjust the hedging relationship as well as to facilitate the proposed hedge effectiveness requirements.
Constituents generally supported the introduction of rebalancing the hedging relationship in order to address the issues under IAS 39 regarding dedesignation and redesignation. However, the requirement for mandatory rebalancing raised questions among constituents who requested additional guidance. In particular, they requested guidance on: 1) what level of risk management should be considered for purposes of rebalancing (risk management strategy vs. risk management objective) and 2) the relationship between rebalancing and changes to hedged volumes or amounts. Some constituents also felt the requirement to rebalance should instead be voluntary, noting the exposure draft implies a continual optimisation of 'the perfect hedge ratio', but that in practice risk management may choose not to rebalance a hedging relationship either because doing so would not be cost effective or because the hedging relationship is still within managements acceptable tolerance limits.
During the 12 May 2011 meeting, the Board tentatively decided to change the hedge effectiveness assessment. Those changes (subject to drafting changes) include that the designation of a hedging relationship would be based on the quantity of hedged item that it actually hedges and the quantity of the hedging instrument that it actually uses to hedge that quantity of hedged item provide that it does not reflect an imbalance that would create hedge ineffectiveness in order to achieve an accounting outcome that is inconsistent with the purpose of hedge accounting.
The staff believes it is therefore necessary to align the rebalancing requirements with the tentative decisions on hedge effectiveness assessment. The staff recommended that after the inception of a hedging relationship, rebalancing would occur when an entity adjusts the quantities of the hedging instrument or the hedged item in response to changes in circumstances that affect the hedge ratio of that hedging relationship. However, the hedging relationship for hedge accounting purposes would have to use a different hedge ratio than for risk management purposes if:
the adjustments for risk management purposes would result in a hedge ratio that would reflect an imbalance that would create hedge ineffectiveness in order to achieve an accounting outcome that is inconsistent with the purpose of hedge accounting or
for risk management purposes an entity would retain a hedge ratio that in new circumstances would reflect an imbalance that would create hedge ineffectiveness in order to achieve an accounting outcome that is inconsistent with the purpose of hedge accounting (i.e., an entity must not create an imbalance by omitting to adjust the hedge ratio).
By doing so, the staff believes the concept of proactive rebalancing is no longer necessary.
One of the IASB members suggested removing the language of 'in order to achieve an accounting outcome' as he felt that it would be impossible for the Board to make that determination.
Another IASB member mentioned that he had recently heard someone mention that because of rebalancing that an entity would never recognise ineffectiveness. He inquired of the staff why that perception may exist. The staff said it was hard to speculate, but that the exposure draft specifically states that an entity would recognise any ineffectiveness that exists prior to rebalancing the hedging relationship so that perception was incorrect.
The Board tentatively agreed with the staff recommendation to align the rebalancing guidance with the new hedge effectiveness assessment approach.
Discontinuing the hedging relationship
The hedge accounting exposure draft proposes that an entity would discontinue the hedging relationship when the qualifying criteria are no longer met (i.e., the hedging relationship no longer meets the risk management objective and strategy) but does not permit voluntary discontinuance when the risk management objective and strategy is unchanged.
Constituents had mixed views regarding the proposals for discontinuing the hedging relationship. Those supporting the proposal felt it would reinforce the link between risk management and accounting and would improve financial reporting by eliminating a structuring opportunity. Some of those constituents did request additional guidance around the meaning of 'risk management' and at what level risk management should be considered (i.e., the entity wide approach to hedging or a transaction level hedging relationship). However, others felt that entering into hedge accounting was optional and therefore discontinuing hedge accounting should also be optional. In particular, some constituents noted the issues around using voluntary dedesignation as a surrogate approach for portfolio hedging (e.g., banks managing their loan books for interest rate risk when the characteristics of the loan portfolio are constantly changing).
From the constituent feedback received, the staff identified two issues for the Board's consideration 1) whether voluntary discontinuation should be allowed and 2) if clarification is needed regarding the link between the proposed discontinuation requirements and the risk management objective and strategy.
Most of the Board members stated their support for the proposals in the exposure draft as they felt permitting voluntary designation when the initial risk management objective and strategy have not changed would be inconsistent with the overall rational of the project of the accounting better reflecting the risk management activities. They also felt that not permitting voluntary dedesignation works as an anti-abuse clause. One Board member went so far as to express his view that the proposals contained inconsistent logic in that application of hedge accounting was optional while discontinuance was not voluntary; he felt the Board should consider making application of hedge accounting mandatory to be consistent with the approach for discontinuance.
Another Board member raised the topic of the interaction with IAS 8Accounting Policies, Changes in Accounting Estimates and Errors and accounting policy choices and questioned if an entity made an election to no longer apply hedge accounting entity wide as an accounting policy election if that would be a permitted dedesignation. Both the staff and another Board member felt that hedge accounting is qualified on a transaction by transaction basis and therefore would not be an overall accounting policy election.
One Board member did not support the restriction to not permit voluntary dedesignation. He felt doing so added complexity that people were having difficulty understanding. Additionally, he felt that it was easy enough to circumvent the restriction to not allow for dedesignation by either terminating the hedging instrument or entering into an offsetting position and felt that creating such a restriction did not benefit the hedge accounting model. The incoming deputy Chair also expressed his concern with not permitting voluntary dedesignation.
Ultimately, the Board tentatively decided to retain the prohibition in the exposure draft that voluntary discontinuation of hedge accounting would not be permitted if the risk management strategy and objective remained unchanged. However, additional guidance will be included for instances where hedge accounting is a 'surrogate' for portfolio hedging (e.g., banks managing their loan books for interest rate risk when the characteristics of the loan portfolio are constantly changing) and for hedging relationships that at a specific stage automatically convert to a natural hedge (e.g., hedging foreign currency risk for forecast sales or purchases denominated in a foreign currency). The final standards will also include enhanced guidance on risk management strategy and risk management objective (i.e., risk management strategy is the entity wide approach for managing risk where as risk management objective is the transactional level application of the hedging relationship).
Options as hedging instruments
The Board began discussions on the proposals in the exposure draft related to the accounting for time value of options used as hedging instruments in a hedging relationship. The exposure draft introduced an 'insurance premium' view for the time value of options (i.e., the time value is the cost of hedging). The time value component would be recognised in other comprehensive income and then either expensed for time period related hedges or basis adjusted (or left in OCI) for transaction related hedges.
Two Board members expressed reservations with retaining the proposals in the exposure draft. One noted that he felt the proposals added unneeded complexity and would prefer to see the time value component frozen at inception rather than having the volatility impacting earnings as currently happens under IAS 39. The other Board member felt that the 'cost of insurance' should be recognised in earnings during the coverage period rather than waiting to basis adjust the hedged item for transaction related hedges. However, the Board tentatively decided to retain the proposals in the exposure draft related to the accounting for time value of options.
Constituents had requested additional clarity on the application of the proposals for the accounting for the time value of options, particularly related to differentiating between transaction related and time period related hedged items. The Board tentatively decided to provide additional guidance on the accounting for time value of options including guidance that the amortisation period does not necessarily have to correspond to the period of the hedging relationship but rather to the period over which the hedge adjustment for intrinsic value can affect profit or loss.
Some constituents had suggested the Board establish a principal to assist in better understanding the difference between transaction and time period related hedged items. However, the Board tentatively decided not to create a principal as the suggested principal would not address all items such as hedges of firm commitments.
Some constituents had also suggested that the application of the proposed accounting treatment for time value of options be an accounting policy choice because of the operational complexity associated with the proposals. However, the Board tentatively decided not to introduce an accounting policy choice for the accounting for the time value component of options used as hedging instruments.
Net written options
The hedge accounting exposure draft proposes that a derivative instrument that combines a written option and a purchased option (e.g., an interest rate collar) does not qualify as a hedging instrument if it is a net written option. Similarly, two or more instruments may be designated as the hedging instrument only if none of them is a written option or a net written option.
Constituents have requested the proposals related to net written options be amended so that stand-alone written options combined with other designated hedging instruments that do not result in a net written option be eligible as hedging instruments. This request focuses on the fact that entities will often enter into two separate option contracts that mirror a collar contract rather than a single collar contract because 1) stand alone option contracts are more widely available and therefore more economical as well as reducing credit risk associated with the contract.
One of the Board members was opposed to expanding the use of written options as hedging instruments feeling it would add additional complexity to the hedge accounting requirements. However, other Board members supported the use of multiple contracts that include a component as a written option so long as the net contract was not a net written option and the terms of the options were aligned. The Board tentatively agreed to permit a combination of a written and a purchased option, regardless of whether the instrument arises from a single or multiple contracts, as an eligible hedging instrument unless the combination results in a net written option.
The IASB discussed the effective date of the forthcoming comprehensive income amendments to IAS 1.
The IASB is expected to issue its standard related to financial statement presentation of other comprehensive income during mid-June. The Board had previously made a tentative decision that the effective date for the amendments would be for periods beginning on or after 1 January 2012. However, the FASB has recently decided to require an effective date for periods beginning on or after 1 July 2012. As the IASB usually provides at least twelve months for implementation of new standards, and to coincide with the effective date of the FASB, the Board tentatively agreed to delay the effective date until periods beginning on or after 1 July 2012.
This discussion concluded the 31 May to 2 June IASB meeting.
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