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Conceptual Framework - Initial and subsequent measurement

Date recorded:

The staff presented to the Board an early draft of the section on initial and subsequent measurement that would be included within the Conceptual Framework discussion paper (DP).  The Staff noted that this section of the DP would discuss:

  • Initial and subsequent measurement of assets and liabilities;
  • How the relevant measurement method for a particular asset or liability would depend on the way that the value of the asset would be realised or the obligation that creates the liability would be fulfilled; and
  • A proposition to use the same method for initial and subsequent measurement

The Staff noted that the section of the DP on initial and subsequent measurement would propose that the appropriate measurement basis would be selected based upon subsequent measurement considerations – i.e. that you should try to use the same method for initial and subsequent measurement unless there was a good reason from not doing so.

The Staff asked the IASB whether they agreed that the choice of subsequent measurement should drive the choice of initial measurement.

One Board member commented that this question could be extended to also include the use of the OCI as he noted that if subsequent measurement was fair value then this would be a good argument for use of the OCI.

Two Board members commented that the Staff analysis in the draft DP supporting this question did not lead to the conclusion that subsequent measurement was driving the initial measurement but just that the measurement bases (i.e. initial and subsequent) should be the same.  The Staff noted that there is not normally a question as to how one would measure on day 1 (i.e. if cost is the same as fair value for instance).  However the Staff noted that if, for instance, cost was not equal to fair value one would need to consider how to measure on day 1 and then consider how they would likely measure on day 2.  The Staff noted that this section of the DP was trying to highlight that where there is a choice of measurement on day 1, one would logically consider the day 2 measurement also especially where it was intended to keep the measurement bases the same.  The Staff noted that they could change the DP wording to make this clear that it was not simply stating that subsequent measurement should always drive initial measurement but it is a consideration where there is a day 1 measurement choice.

Notwithstanding the above Board comments and suggested changes, the majority of Board members tentatively agreed with the Staff proposal for inclusion in the DP.

The Staff noted that the section on initial and subsequent measurement in the DP would note that there were 4 different ways that the value (capacity to contribute to future cash flows) of an asset could be realised and each of these different ways would have different implications for choosing an appropriate measurement method.  These would be:

  1. Using it in ones own business operations to contribute directly or indirectly to generating revenues or income;
  2. Selling it;
  3. Holding it for collection according to terms; and
  4. Charging others for the rights to use it.

The DP would note that the entity will have choices over the method of realisation for their assets (not all will have one possible method of realisation) and the IASB would need to decide how to deal with these uncertainties when considering asset measurements.  The Staff noted that the section on initial and subsequent measurement in the DP may state that measurement requirements should be based upon the most profitable means of realising an assets value or another method may be to measure based on the most probable cash flow outcome.

Using assets

The Staff noted that the section on initial and subsequent measurement in the DP would state that under this method of realisation cost – based measures would be appropriate.

Selling assets

The Staff noted that the section on initial and subsequent measurement in the DP would state that under this method of realisation current – based measures would be appropriate such as fair value.

One Board member commented on the assertion in the DP that cost would be the best measurement for investment property.  This member commented that there were also arguments for measuring investment properties at fair value and hence did not want the Conceptual Framework to be advocating that only cost was appropriate.

Holding assets for collection

The Staff noted that these would be mainly financial instruments.

The Staff noted that the section on initial and subsequent measurement in the DP would state that under this method of realisation fair value measurement would be appropriate for assets that are derivative financial instruments or hybrid instruments or do not have interest-like returns.  The Staff noted that derivatives have highly variable cash flows and hence the justification for fair value measurement.  One Board member commented that this was not always the case (i.e. a forward would have a single fixed cash flow at some point in the future) and also noted that there were other reasons for measurement at fair value as opposed just to cash flow.  The Staff noted that they would change the DP to make reference to variability of outcomes.

The Staff noted that the section on initial and subsequent measurement in the DP would state that under this method of realisation accrual based measures would be appropriate where an entity holds for collection assets that have interest like returns and little variability in cash flows.  The Staff also noted that the DP could distinguish measurement between those purchased loans, bonds and receivables and originated loans and receivables.

One Board member commented that for hybrid instrument there should be a discussion of separating the embedded derivative and the complexities that this poses on measurement.  The Staff noted that this was briefly discussed in the elements section but not in as much detail as was being asked.  The Board member noted that the current version of the DP stated that as soon as there was a hybrid instrument one would automatically measure using fair value which would not be correct to assume.  The Staff acknowledged this Board member request.

Due to the Board comment re derivatives, the Staff noted that the next DP would include a discussion on hedging and impact on measurement.

Charging for rights to use assets

The Staff noted that examples of this value generation would be leasing, renting, franchising etc.

The Staff noted that the section on initial and subsequent measurement in the DP would state that the most relevant measure that justifies its cost for charge-for-use assets would vary depending upon the specific nature of the asset.

The Staff asked the Board whether they agreed with the proposed discussion in the DP regarding the ways that values of assets can be realised and the implications for measurement.

One Board member commented that within paper 3b paragraph 21 there were a number of other uses for assets that should be aligned with this section of the DP (and any uses that have not been discussed should be discussed in the DP and impact on measurement).  Another Board member asked where hedging was covered – the Staff noted that this was not covered in the current version of the DP and would be included in the next draft.  A number of Board members asked that the analysis in the DP be made between direct and indirect uses of the assets as was the case in paper 3b.  The Staff noted that this analysis could be performed in the next draft but considered that the drafting as it currently stood did have a direct and indirect approach but this was not explicitly stated.

One Board member asked whether the DP should include a discussion of the business model in this section of the DP as this would drive the use of the asset.  The Staff noted that in this section of the DP there could be a broad discussion of the business model but noted, as in previous discussions on the other sections of the DP, the business model covers a number of other areas.

Overall there was a general amount of Board agreement for the proposed discussion in the DP regarding the ways that values of assets can be realised and the implications for measurement in the DP.  However, it was tentatively agreed that changes were required in line with the Board comments above.

The Staff noted that the section on initial and subsequent measurement in the DP would note that there were (at least) 4 different ways that an entity could fulfil the obligation within a liability and each of these different ways would have different implications for choosing an appropriate measurement method.  These would be:

  1. Settling it according to its terms;
  2. Performing services, or hiring others to perform services, to satisfy a claim with no stated amount;
  3. Settling a claim that has no stated or determinable amount by negotiation or in litigation; and
  4. Transferring the obligation to another party and being released by the creditor or other claimant.

Settling a liability according to terms

The Staff noted that the section on initial and subsequent measurement in the DP would state that an accrual-based measure would be considered appropriate for many contractual liabilities except for some financial instruments.  The DP would state that derivatives that are liabilities should be measured at fair value or another measure that varies according to the cash flows required by the contract.

Performing services or paying others to perform services

The Staff noted that the section on initial and subsequent measurement in the DP would state that where liabilities arise from a contract with a customer, an accruals-based measure would be appropriate.  The DP would also state that there are some liabilities that are imposed by statute or judicial or regulatory action and the entity receives no payment for them (such as an obligation to remedy environmental damage – the lack of proceeds distinguishes these from contracts that impose performance obligations for which the obliged party is paid).

The Staff noted that in section on initial and subsequent measurement in the DP would state that for the later obligations, the only realistic option for measurement was to use a computation involving an estimate of the cash flows necessary to perform or hire the services (discounted if long term).  The Staff noted that the DP would highlight that in these measures there would be issues with estimating uncertain cash flows and the discount rate used.

Settlement of a claim by negotiation or litigation

The Staff noted that in section on initial and subsequent measurement in the DP would state that the only realistic option for measurement was to use a computation involving an estimate of the cash flows necessary to perform or hire the services (discounted if long term).  The Staff noted that the DP would highlight that in these measures there would be issues with estimating uncertain cash flows and the discount rate used.

Transferring a liability

The Staff noted that in section on initial and subsequent measurement in the DP would state that very few liabilities can be transferred to a third party without negotiating for the consent of the creditor.  The DP would state that the most relevant measure would be fair value because it is the estimate of the cash that would be paid to induce the other party to assume the liability.

The Staff asked the Board whether they agreed with the proposed discussion in the DP regarding the ways that obligations inherent in liabilities could be fulfilled and the implications of these for measurement.

One Board member questioned where a pension liability would sit within the four categories.  The Staff noted that it would be included within category (a) – settling according to contractual terms like a derivative.

Another Board member commented that the DP should not be stating that one use for a particular asset or method of settling a particular liability should be linked to one measurement – i.e. that there was only one measurement for each situation and when another method for settling a liability or using an asset was considered there would be a new measurement.  She wanted to ensure that the DP did not customise a measurement basis for each situation and that one measurement could be used for more than one situation.  The Staff noted that this could be brought out in the DP.

One Board member noted that there were a number of questions within paragraph 43 of the DP that were just left as questions.  The Board member asked whether the DP would answer these questions and the Staff noted that these would be a focus of the next version of the DP.  The Board member noted that these questions are the most difficult to answer for liabilities and hence should be the main focus of the section in the DP and not just referred to in the DP as requiring a standards level decision.  The Staff agreed.  One Board member requested that these questions also be analysed from the perspective of assets as well as liabilities – the Staff agreed that the next version of the DP would include this.

Overall there was a general amount of Board agreement for the proposed discussion in the DP regarding the ways that obligations inherent in liabilities could be fulfilled and the implications of these for measurement.  One Board member did not agree with the proposal in the DP.  It was tentatively agreed that changes were required in line with the Board comments above.

The Staff then presented to the Board issues unique to initial measurement that would be included within the DP.  Such issues would include where

  • the cost of an asset or liability determined according to the fair value of the consideration given differed from its fair value at the recognition date;
  • recognising assets, liabilities or equity instruments for reasons other than an exchange of consideration of equal value (for example where an entity acquires an asset, incurs a liability or issues an equity instrument for nil consideration – measure at zero or most likely measure on the same basis as subsequent measurement or use fair value as deemed cost if the subsequent measure is based on cost); and
  • two items of different value are exchanged (the DP would discuss problems with recognising the cost of the asset acquired or the proceeds from the liability incurred as this may result in failure to recognise a realised economic gain or loss on an unstated aspect of the transaction – e.g. a capital contribution).  The Staff noted that the section on initial and subsequent measurement in the DP would also discuss ways to initially measure assets acquired in unequal exchanges)

The Staff asked the Board whether they agreed with the discussion of the issues inherent in initial measurement that would be included within the DP.

No significant Board comments were received in relation to this part of the DP.  The majority of Board members tentatively agreed with the discussion of the issues inherent in initial measurement that would be included within the DP.