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Conceptual Framework — Education session (IASB only)

Date recorded:

The IASB held an education session to discuss two topics within the conceptual framework project.  The Staff presented two sets of slides to the IASB Board members:

  • Measurement – this paper provided some background information on the concepts of measurement within the Conceptual Framework and discussed whether there should be a mixed-measurement or single measurement approach; and
  • Liabilities/Equity – this paper provided some background information on the definitions of liabilities and equity in the Conceptual Framework and the possible approach to addressing the liabilities/equity boundary at a conceptual level.

Measurement

The Staff provided some background information on the concepts of measurement and began by highlighting that measurement has an effect on both the statement of financial position and the performance statements.  The Staff noted that there may be an effect on the performance statements due to initial recognition, on remeasurement, on de-recognition and consumption.

The Staff highlighted to the Board that the existing framework does not provide guidance and says very little on measurement and what it does say is not very helpful to users.  They also highlighted that there were other problems with measurement such as:

  • Whether there should be one basis of measurement or many;
  • Defining the different measurement bases;
  • Understanding when the different measurement bases should be used; and
  • Whether initial and subsequent measurement should be the same

The Staff noted that in addressing the above problems with measurement, the Board should build on the work that has already been performed in chapters 1 and 3 of the Framework being the Objectives of Financial statements and Qualitative characteristics where previously at another Board meeting it was decided that these areas would not be addressed in the current project as they were considered adequate as they stand.

The Staff noted that in determining the solutions to the above problems consideration to the Objective of financial statements should be made, for instance the measurement basis selected should be able to meet the Objective criteria of Chapter 1, namely:

  • Should inform users about the entity’s resources and obligations;
  • Should inform users about the effect of transactions and other events on the resources  and obligations; and
  • Should inform users how effectively management has discharged their responsibilities

The Staff also noted that the measure selected should also address the Qualitative characteristics mentioned in Chapter 3 of the Conceptual Framework such as relevance, faithful representation and be a useful measure.  It was also noted that cost/benefit considerations would need to be addressed in selection of the measure.

The Staff then presented the advantages of using a single measurement basis (such as current value or cost) noting that this would increase comparability.  However they noted that one measurement basis may not be suitable in all circumstances (such as derivatives where their initial cost is zero).  They also noted that current value would be less relevant where the intention was to use an asset where cost may be more appropriate.

The Staff advocated that a mixed measurement basis would be their preference where the most suitable measurement basis could be selected depending on what was being measured.

One Board member favoured a single basis as he said that a mixed basis may lead to complexity in application.

Three main measurement bases were presented to the Board being:

  • Cost – based
    • By this the Staff meant that something starts at cost on day 1 and then moves over time with, for example, depreciation.  Initial measurement for an asset would be cash paid (or fair value of the consideration) and the cost would then be reduced as the asset if consumed.  Initial measurement for a liability would be cash received (or fair value of other consideration) and the liability would then be reduced as the obligation is satisfied.
  • Current
    • The Staff gave an example of “building blocks” used in the Insurance contract project – cash flows, time value and risk.  A current measure would keep each of these areas current and updated.
    • The Staff noted that there would be more than one current measure (fair value, replacement cost, fair value less costs to sell) and one question would be whether the number of current measurement bases should be reduced.  The Staff grouped the current measures between a market participant and entity specific perspective
    • It was noted that the measure selected may be influenced by the availability of information.
  • Mixed
    • By this the Staff meant that where there current values were used for some but not all aspects of the items being measure, for instance amortised cost for financial instruments.  An example given by the Staff was fair value hedge accounting where the fair value is updated for changes arising from the hedged risk but is not updated for changes arising from other factors.

The Staff presented to the Boards examples where they thought that each measure would be used.  They noted that a cost basis would be more likely to be used when consumption of service potential is relevant, when items are expected to be sold in a retail market (as opposed to a broker/dealer market) and when the costs associated with current measurement outweigh the benefits.  The Staff noted that a current basis would be more likely to be used where an entity expects to sell assets (e.g. investment properties), where items are sold in a dealer market and for items whose value is expected to change significantly (consumer biological assets).  Mixed measures were likely to be used where one aspect of an item is less relevant than other aspects (i.e. interest rates on debt instruments if the business model is to collect contractual cash flows) and where it helped to eliminate accounting mismatches.

One Board member emphasised that the entity’s business model should be taken into consideration when selecting the measurement basis and noted that he wanted this element to be introduced to the discussion.  The Staff noted that the term “business model” could be used and emphasised that the above were only indicators to help determine which measurement basis to use and this would not be a straight forward decision making process.

The Staff noted that they considered that initial measurement and subsequent measurement should be the same.  If this was not the case on day 1 and day 2 then there would be a gain or loss on day 2 purely as a result of a change in the measurement basis and is not a real-world event.

The Staff then highlighted to the Board other measurement issues.  They noted that the framework does mention capital maintenance.  They noted that this should not be dealt with in the discussion paper on the Conceptual framework.

A number of Board members agreed that the discussion paper should not cover capital maintenance.  One member noted that in the discussion paper it could be noted that a stable measuring unit is assumed.  The Staff agreed that this would be included in the discussion paper.  One member expressed a concern on not addressing capital maintenance at all.  Another Board member agreed and stated that the project should be problem focused only.

The Staff noted that recoverable amount and deprival value may also need to be considered in determining whether these were measures themselves or a means to determine which measure should be selected.  These were not discussed these any further.

One Board member asked whether in the discussion paper there would be preliminary views on measurement and questioned how this would be achieved.  The Staff noted that they would aim to get preliminary views in the discussion paper.  This Board member also noted that it was important to get user views for the Staff to be able to form their conclusions/views in the discussion paper.

No Board decisions were taken on this paper.

Liabilities/Equity

The Staff presented a paper providing some background information on the definitions of liabilities and equity in the Conceptual Framework and the possible approach to addressing the liabilities/equity boundary at a conceptual level.

The Staff presented the current definitions of liabilities and equity to the Board and noted that, in practice, there are problems with applying these definitions and distinguishing between liabilities and equity.

A liability is currently defined as a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Equity is currently defined as the residual interest in the assets of the entity after deducting all liabilities.

The Staff noted that within the liabilities definition there were two key elements that are important when considering the liability/equity boundary.  These were

  • Obligation to transfer economic benefits
  • The obligation must be the obligation of the entity

Hence the entity must have an obligation for there to be a liability.

The Staff noted that there were a number of current problems with the liability/equity boundary and the definition was not always applied in practice.  Those problems, stemming, from among other things, IAS 32 implementation issues (where specific rules that go against the basic liability definition are used which add to the problems in applying the liability/equity concept), included:

  • Puttable instruments – may be treated in some situations as equity even though there is a clear obligation for the entity to transfer economic benefits when these instruments are put
  • Transactions settled in an entity’s own shares – IAS 32 treats these transactions as liabilities (unless they represent an exchange of a fixed amount of shares for a fixed amount of cash) even though there is no obligation for an entity to transfer economic benefits

The Staff noted that these problems would need to be addressed when looking at the Conceptual Framework project.

It was noted that the Board had previously tried to resolve the issues of the distinction between liabilities and equity in their Financial Instruments with Characteristics of Equity (FICE) project.  This attempted to define which financial instruments should be classified as equity.  The Staff noted that this project did not use the definition of a liability and equity was not viewed as the residual.  The project tried to define equity but was paused in November 2010.

The Staff noted that the current definition of a liability, as noted above, focuses on whether the entity has an obligation and that this causes concerns for some financial statement users. Where there are instruments that do not create an obligation but embody different rights from the rights of ordinary shareholders, these are classified as equity (for instance preference shares).  Some financial statement users do not consider that this classification addresses the needs of ordinary shareholders and that equity should be more narrowly defined to address their information needs.  The Staff noted that they did not consider that this would meet the objective of financial reporting to provide information to a wide range of users but did present to the Board an alternative that would expand the statement of changes in equity to display how future cash flows will be distributed between equity holders and would address some of these issues.

The Staff proposal for addressing the liability/equity problem would maintain the definition of liabilities and would continue to treat equity as a residual rather than defining equity.  The statement of changes in equity would also be expanded to attempt to address the user concerns that they are not receiving the information they want for their particular class of equity.  The Staff noted that this approach would be more consistent with applying the liability definition and would also still attempt to address user needs.

One Board member proposed that an equity instrument should be defined and would have to have three characteristics:

  • No stated maturity or mandatory redemption
  • No required fixed payment
  • Highest and same degree of loss absorption

The Board member noted that the first 2 characteristics were essential for something to be equity.  This view to define equity was not shared by other Board members where equity being a residual was preferred.

Another Board member noted that the issues that were discussed had already been discussed in the liabilities/equity project where there was limited success in resolving them but acknowledged that they would need to be addressed in the Conceptual Framework project.  He supported the Staff proposal to expand the statement of changes in equity and portraying the transactions between different classes of equity investors.  This Board member noted that the statement of changes in equity could be split into two sections with one section showing transfers of wealth between different components of equity (non-controlling interest, preference shareholders etc.) and another section showing transactions with equity investors.  This would then enable users to concentrate on the area of most relevance to them.  The Staff agreed that this could be adopted or a one part statement of changes in equity with sub totals to the same effect

No Board decisions were taken on this paper.