Conceptual Framework - Definition of elements (IASB)
The staff presented to the Board an early draft of the section on elements (definition of elements) that would be included within the Conceptual Framework discussion paper (DP). The Staff noted that it was important that the work in the DP built upon the relevant sections in Chapters 1 and 3 of the Conceptual Framework so that there was alignment in approach. The Staff also noted that Chapters 1 and 3 discuss Financial Reporting of which Financial statements are a part. They noted that financial reporting also includes such things as interim reporting, management commentary etc. However it was noted that the DP would only focus on financial statements and not on broader aspects of financial reporting. It was considered that the other areas of financial reporting were important but the Staff were of the view that the Framework should be put in place for financial statements first (the Staff noted that the Board could look at these additional financial reporting aspects at a later date if they wished to). These additional aspects would not be discussed in the DP the ED or the finalised framework.
Some Board members noted that Chapter 1 sets out the objectives of financial reporting and not the objective for financial statements. They questioned whether Chapter 1 would now therefore discuss an objective for financial statements (if this objective was seen as different to that of financial reporting) in light of financial reporting not being the focus of the DP. These Board members questioned whether it would be highlighted that the objective of financial statements were a subset of the objective of financial reporting and if not when and where the objective of financial statements would be discussed. The Staff noted that the objectives would be the same and they envisaged that some of the objectives of financial reporting would apply to the financial statements.
The draft section of the discussion paper on elements, prepared by the Staff noted that elements are:
- In the statement of financial position – assets, liabilities and equity
- In the statement of comprehensive income – income and expense
- In the statement of changes in equity – income, expense, contributions of equity, distributions of equity, transfers between classes of equity, as well as the opening and closing amounts of equity
- In the statement of cash flows – cash inflows and cash outflows as well as the opening and closing cash balances
The Staff noted that the elements section of the DP would highlight that various improvements could be made to the existing definitions of assets and liabilities (although they did note that the existing definitions were along the right lines in talking about resources and obligations but suggested that essential improvements were required). The DP would note that essential improvements needed to be made to confirm more explicitly that:
- As asset is a resource (rather than an inflow of economic benefits that the resource may generate) (The Staff noted that in practice it was considered that readers sometimes confuse the resource (asset) or obligation (liability) with the resulting inflow (or outflow of economic benefits)
- A liability is an obligation (rather than an outflow of economic benefits that the obligation may generate)
- Although an asset (or liability) must be capable of generating inflows (or outflows) of economic benefits, there is no minimum probability threshold that those inflows (or outflows) must reach before a resource (or obligation) qualifies as an asset (or liability). (It was noted that the existing definitions include the notion that future economic benefits (or a future outflow of resources) must be “expected” and some have viewed this to mean that a probability threshold is required to be reached before an asset or liability is recognised. It was noted that such a probability threshold would exclude such items as purchased options that are clearly assets).
The Staff also noted that the draft discussion paper could introduce other improvements that were not considered essential but would streamline the definitions without changing the meaning. Such improvements would:
- Move the definition of control from the definition of an asset into the recognition criteria
- Delete the reference to past events as it was considered that the requirement for an asset to be a present resource and a liability to be a present obligation already includes the notion of a past event (The Staff noted that the key point was whether the asset of liability existed today although did note that if alternative “C” was selected from paper 3C (see minutes on 18 February) then past event may need to be re-considered for inclusion within the definition in the DP).
- Move the reference to future economic benefits into a new definition of economic resource. It was considered that this would make the definition of an asset more concise and would also permit a more focussed definition of a liability as an obligation to transfer economic resources. The Staff noted that these changes would reinforce the message that the asset (or liability) is the resource (or obligation) not the flows of economic benefits that may result.
- Add additional guidance supporting the definitions for assets and liabilities
The Staff proposed that the elements section of the DP include the following definitions of assets, liabilities and economic resource:
- Asset – a present economic resource
- Liability – a present obligation to transfer an economic resource
- Economic resource – a scarce item that is capable of producing economic benefits for the party that controls the item
The Staff noted that the DP would include further guidance to support the definitions of an asset and liability in the areas of:
- Economic resources
- Contractual rights and contractual obligations
- Executory contracts
(The Staff noted that a right was one type of economic resource and although rights were used in many situations to describe the economic resource the definition of an asset and liability would still keep economic resource in the definition)
The Staff noted that the proposed definition of an economic resource would include the notion that the resource was:
- Scarce (this was intended to convey the idea that the item would generate economic benefits only for the party that controls it)
- Capable of producing economic benefits
The Staff noted that economic resources could take various forms such as:
- Enforceable rights established by contract law or similar means:
- Enforceable rights arising from a financial instrument, such as an investment in a debt security or an equity investment
- Enforceable rights over physical objects, such as property, plant and equipment or inventories. Such rights might include ownership of a physical object, the right to use a physical object, or the right to the residual value of a leased object
- Enforceable rights to receive another resource if the holder of the right chooses to exercise that right (an option to acquire the underlying resource) or is required to exercise that right (a forward contract to buy the underlying resource). Examples include options to receive other assets, net rights under forward contracts to buy or sell other assets, rights to receive services for which the entity has already paid, rights to benefit from stand ready obligations
- Enforceable intellectual property rights (e.g. registered patents)
- Other economic resources if they both (i) are capable of generating economic benefits to the party that controls the economic resource and (ii) do not generate economic benefits for other parties. Examples would be know how, customer lists.
The Staff noted that the DP guidance would clarify that economic benefits derived from an asset were the potential cash flows that could be obtained directly or indirectly such as by:
- using the asset to produce goods or provide services
- using the asset to enhance the value of other assets;
- using the asset to fulfil liabilities or reduce expenses;
- selling or exchanging the asset;
- receiving services from the asset.
- pledging the asset to secure a loan; or
- holding the asset.
The Staff also noted that the guidance in the DP would clarify that for a physical object, such as an item of PPE, the economic resource is not the underlying object but a right (or set of rights) to obtain the economic benefits generated by the physical object.
The Staff noted that economic resources would comprise different rights such as the right to use the asset, the right to sell the asset, the right to pledge the asset and legal title to the asset. The Staff noted that each of these rights is capable of being a separate asset but in many cases the entity would treat all of the rights as a single asset. It was noted that the entity would treat some of the rights as one or more separate assets if such separation would provide users with information that is relevant and provides a faithful representation of the resources at a cost that does not exceed the benefits of doing so.
Contractual rights and obligations
The Staff highlighted that it would be useful for the DP to consider contracts at a general level as these are usually included at a standards level.
The Staff noted that the DP would suggest that entering into a contract gives rise to rights and obligations if (and only if) those rights and obligations are enforceable. The Staff noted that the DP would state that if neither part is bound by a particular term in the contract, that term has no commercial substance and so is not a source of rights and obligations. Hence that term does not qualify for recognition as part of an asset (assets) or liability (liabilities) arising from that contract.
It was noted that the unit of account would determine whether a contract was viewed as giving rise to a single net right or net obligation or to one or more separate rights and obligations and liabilities.
The Staff noted that the DP would include a comment that a net asset or net liability would arise under an executory contract if the contract was enforceable. Some Board members questioned why a gross asset or gross liability would not arise and why the draft section on elements to be included in the DP was assuming a net position in all situations.
Another Board member commented that if it was decided that the unit of account was a net notion (for executory contracts and other types of contracts) then there should be a requirement in the framework, and not at a standards level, that the changes in these elements should be disclosed separately in the notes to aid transparency for the user of the financial statements.
Definitions of income and expense
The Staff explained to the Board that they did not propose significant changes to the existing definitions of income and expense in the DP – a number of Board members tentatively agreed to this. The Staff noted that they thought that only drafting changes were needed to the existing definitions. The Staff noted that there would be a section of the DP that will discuss how to distinguish profit or loss from OCI by either (these were the more substantive questions that needed to be solved re income and expense):
- identifying one set of elements for inclusion in profit or loss and a separate set of elements for inclusion on OCI (the Staff noted that at this stage no conclusion could be reached until the OCI question was solved – i.e. a distinction between profit or loss and OCI criteria), or
- identifying a single set of elements for inclusion in both profit or loss and OCI, and establishing presentation concepts that identify which types of income and expense would be presented in profit or loss and which would be presented in OCI.
The Staff asked the Board whether they had any comments on the definitions of income and expense
No significant Board comments were received in relation to the income and expense definitions.
Unit of account
The DP would note that the level of aggregation of rights and obligations is referred to as the unit of account. It would state that the unit of account that would provide the most useful information to existing and potential investors, lenders and other creditors would normally be a standards level decision. The Staff noted that the DP would discuss that the unit of account selected must:
- provide relevant information
- faithfully represent what it purports to represent
- The costs associated with the selected unit of account must exceed the benefits
The Staff noted that in some situations the IASB may have to specify a unit of account (to ensure comparability either between entities or over time) and some cases they may not need to (if the unit of account is unlikely to affect the recognition or measurement of assets and liabilities). The Staff noted that there would be an expectation that something was said in the Conceptual Framework about unit of account.
The Staff provided a high level overview of paper 3E on recognition and de-recognition and noted that this would be considered in more detail in the discussions on Wednesday. The Staff did not have time to discuss de-recognition during the meeting. The Staff discussed the concept of control and noted that the DP would deal with the discussion of control in the recognition criteria rather than in the definition of an asset.
The Staff also discussed the concept of uncertainty and whether the framework should provide any guidance as to the certainty threshold that was required to determine whether an asset or liability should be recognised. The Staff proposed that the DP state that a virtually certain threshold should be met (i.e. an asset or liability should not be recognised until it was virtually certain that the entity controls the asset or is bound by the liability).
The Staff asked the Board whether they agreed with the proposed definitions for an asset, a liability and economic resource. The Staff also asked the Board whether they had any further comments on the proposed guidance in the DP.
One Board member commented on the word “scarce” in the proposed definition of an economic resource. He noted that the notion of scarce depends on who and where a party was. He noted that the notion of scarce was a matter of accessibility. He also noted that the use of the word scarce in the definition of an economic resource would convey a degree of judgement – some resources would be scarce for some and not for others. The Chair clarified that the use of the word scarce was intended to be used in the same way as it is used in economics that has a known meaning.
Another Board member noted that he liked the general direction that the Staff definitions were going but commented that the real issue with an economic resource is whether it is controlled by the entity. This Board member argued that the proposed definition of an asset could be changed to include the notion of control (i.e. an asset is an economic resource controlled by the entity) – another Board member did not want the notion of control being replaced by the notion of scarcity. The Staff noted that they could instead change the definition of an economic resource to make reference to the notion of control. This appeared to gain some tentative Board support. Some Board members put forward a view as to whether control should be dealt with in the definition section rather than the proposed move to recognition.
Another Board member did not agree with the Staff proposals for the elements section of the DP. He favoured a longer definition that included such concepts as control and noted that he preferred the existing definitions within the Conceptual Framework. This Board member preferred a more comprehensive definition. This Board member also expressed caution with removing the probability threshold in the existing recognition criteria in favour of a virtually certain model – he noted that this step would represent a major change. This Board member also wanted the DP to include a more comprehensive list of problems and issues that the DP was trying to solve aside from those that are currently included in the draft of the elements section of the DP – this would enable the consequences of the changes being proposed to be really understood and thought through. This view was shared by two other Board members who would also like to understand the consequences of the new definitions in practice and whether there are any unintended consequences. These Board members noted that these discussions should be included in the DP so that users can understand the impact of the new definitions.
Another Board member expressed general support for the direction of the elements section of the DP. She also supported moving control to the recognition section of the DP. This Board member proposed that the elements section of the DP discuss how a reporting entity’s business model may be used to determine the unit of account and asked the Staff to consider this for the next iteration of the elements section of the DP to be presented to the Board.
One Board member questioned whether the changes to the definitions were required and expressed caution that the Staff should be sure that what they are proposing in the DP were solving existing issues. Another Board member noted that the changes were indeed required and that many of the ideas for change within the DP were borne from issues that FASB Staff had experienced with applying the existing definitions to a number of case studies.
Another Board member also supported the general direction of the elements section of the DP. He asked how the proposed definitions would tie through to the discussions that were held on Monday 18 February especially around the three approaches that were discussed in relation to the recognition of a liability dependent upon an entity’s future actions. The Staff noted that they may need to alter some aspects of the DP is it was decided that approach 3, which included a concept of past events, was favoured by Board members.
No Board decisions were taken in the meeting.
The Staff summarised that, as a result of the discussion they had identified the following key Board comments in relation to the existing version of the elements section of the DP to be addressed in the next iteration of the DP:
- There was broad support to remove the concept of probability from the definition section in the DP (the Staff noted that there would be a later debate as to whether such a notion should be included within the recognition criteria)
- There was broad support that the asset is a resource (rather than an inflow of economic benefits that the resource may generate) and a liability is an obligation (rather than an outflow of economic benefits that the obligation may generate)
- There was no clear view expressed by the Board as to whether to delete the reference to past event
The Staff noted that there was not a discrete section in the DP regarding the business model and how this may be used to determine the unit of account. The Staff noted that they would consider whether there should be a discrete section in the DP.
The Staff noted that these Board comments as well as the others expressed would be incorporated in the April 2013 version of the DP for discussion by the Board.
No Board decisions were taken on the concept of recognition in the meeting. These would be discussed in the Board meeting on Wednesday 20 February 2013.