Conceptual framework

Date recorded:

The session had three topics—Asset definition and supporting concepts (Agenda paper 10B); Recognition (Agenda paper 10C); and Measurement (Agenda paper 10D.  Agenda paper 10A is a summary of decisions made to date.

Conceptual Framework — Asset definition and supporting concepts- Agenda paper 10B

This paper discusses the comment letters received and the staff recommendation on: (a) the proposed definitions of an asset and an economic resource; and (b) the proposed supporting concepts.  The agenda paper discusses the comments that apply to the proposed asset and liability definitions.  Comments on the terms that include “present” and “as a result of past events” will be discussed at a future meeting.

The staff presents a table summarising the existing and proposed definitions:

 

Existing definition

Proposed definition

Proposed supporting concept

Asset (of an entity)

A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

A present economic resource controlled by the entity as a result of past events.

 

Economic resource

[None]

A right that has the potential to produce economic benefits.

 

Liability (of an entity)

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.

A present obligation of the entity to transfer an economic resource as a result of past events.

An entity’s obligation to transfer an economic resource must have the potential to require the entity to transfer an economic resource to another party.

Topic 1 — replacing “expected” with “potential to produce” and “potential to require”

Some respondents disagreed with the proposed definitions, stating that the change would increase the population of items identified as assets and liabilities; increase complexity and inefficiency; be inconsistent with the definitions in IAS 37 and IAS 28; and are not necessary.

The staff considered that the issues should be addressed by considering whether the proposed definitions provide sufficient guidance for items with a low probability of inflows or outflows (see agenda paper 10C and the discussion of recognition). The staff agreed with the suggestion to note in Chapter 4 that not all items meeting the definition of an asset or a liability would necessarily be recognised in the financial statements.

The staff recommended: (a) the requirements for ‘expected’ inflows or outflows of economic benefits  be removed from the definitions of an asset and a liability; and  (b) the Conceptual Framework should instead specify that:  (i) to meet the definition of an economic resource and, hence, an asset, a  right should have the ‘potential to produce’ economic benefits; and  (ii) to meet the definition of a liability, an obligation should have the ‘potential to require’ the entity to transfer an economic resource.

Decision

The Board approved the recommendation.

Discussion

Although there was general agreement with the staff recommendation, Board members raised several concerns. There is a need to clarify the rationale the Board had for choosing this approach and for not taking the suggestions made by some respondents about using the term “probable.” There was concern that the staff agenda paper seemed to indicate that the Board had interpreted the existing definition in the way that is currently drafted. One Board member said that instead the agenda paper should say that in some cases the Board had decided to deviate from the definitions in the current Conceptual Framework because they did not fit well in developing particular standards (i.e. financial instruments and insurance). There were concerns that entities would need to undertake more analysis to identify assets. The staff response was that each standard has a recognition filter that needs to be applied so an entity would not be require to carry out an unlimited search for assets. Board members also said that the Conceptual Framework will be used only when the standard is not clear.

Topic 2 — Defining an asset as a “right”

Most respondents raised concerns on the proposal to define an asset as a right.  Some were concerned about omitting “or other source of value” and others said that the most common understanding of the term right does not encompass items such as know-how and goodwill.  There were also concerns in relation to the right of access to public goods.  They agree that those rights are not assets of an entity but they disagreed with the rationale in the ED.  Instead, they consider that they do not meet the definition of assets because the economic resources are not controlled by the entity.

The staff recommended that the Board confirm the proposals, and that decisions about specific items should be taken when the Board is developing IFRS standards for those items.

The staff recommended retaining the proposal in the ED.

Decision

The Board approved the recommendation, but with redrafting required.

Discussion

Most of the discussion was focused on public goods and which approach suggested by the staff should be applied (see paragraph 49)—elements of each approach were valid. It was suggested that the staff should combine the approach proposed in the ED that indicated that economic benefits are not available to all other parties and the approach suggested by respondents which indicated that economic resources derived from rights that are held by all parties are not assets because are not controlled by the entity.

There were some concerns in relation to the use of the term “right”. One Board member said that the term goes beyond the term right as it is currently used and is difficult to apply to situations in which an entity does not recognise internally generated goodwill (although it is a right) vs the requirement to recognise acquired goodwill. The staff responded that few respondents raised on that area.

Topic 3 — Concepts explaining “controlled by the entity”

The staff noted that there was little feedback received on this topic and recommended retaining the proposal in the ED.

Decision

The Board approved the recommendation.

Conceptual Framework-recognition — Agenda paper 10C

The ED proposes that assets and liabilities should be recognised if this provides users of financial statement with (a) relevant information; (b) a faithful representation of the item; and (c) the benefits of providing that information exceeds its costs. The staff noted the following issues raised by respondents:

Overall approach and removal of probability criterion

Many of the respondents expressed general support for the proposal. However, some respondents disagreed with the approach.  Those respondents thought they were too abstract and subjective and that entities will recognise more assets and liabilities with a low probability of inflows or outflows of economic benefits.

The staff is recommending that the Board confirm the proposed approach in the ED. They considered prescribing probability criteria but concluded that it is difficult to set out a probability approach that could be applicable across all of the Standards.  They think it would be more helpful to provide more direction by enhancing the discussion on assets and liabilities with a low probability of inflows or outflows of economic benefits.

Application of the cost constraint

Some respondents expressed concerns about the proposal to identify cost-benefits considerations as one of the three criteria to be considered in recognition decisions. They argue that the cost constraint should not be given a level of importance similar to that of relevance and faithful representation.  Rather, it is a general constraint, or overarching concept, in financial reporting and that materiality provides a more conceptually sound basis for the decision of whether or not to recognise an asset or liability.

The staff accepts the first concern because it will be consistent with chapter 2 and 6. The staff also noted that the concepts of materiality and cost constraints are not alternatives and have different purposes.  They are recommending that the revised Conceptual Framework identify only relevance and faithful recognition as the criteria for recognition, and not cost-benefit. 

Discussion

The Board approved the staff recommendations.

The main debate related to the meaning of low probability. The staff said that they did not intend to define the term, and that it could mean different things in different circumstances. Also, the lower the threshold the more an entity would need to consider whether recognising an item would provide useful information. There were concerns about the example in the proposed revised paragraph 5.19 of the CF (see Appendix A), which has an exchange transaction and a non-exchange transaction. It is not clear how the low probability criteria applies. The staff noted that those factors are just examples and there could be transactions that have elements of both (for example business combinations).

There were also concerns about the implication, in the proposed paragraph 5.18, that disclosure could be considered a substitute for recognition.

Conceptual Framework — Measurement — Factors to consider when selecting a measurement basis — Agenda paper 10D

Measurement basis

The staff propose including a description of the information provided by current cost and a discussion of the advantages and disadvantages of current cost.  However, in response to respondents who thought it was illogical to discuss current cost under the heading of historical cost that discussion will be moved to be part of the current rather than historical measurement basis.

Characteristic of the asset or liability

Some respondents said that the Conceptual Framework should not identify the characteristics of the asset or liability as a factor to consider when selecting a measurement basis and that the ED failed to explain why sensitivity to changes in value is relevant because the ED did not discuss the notion of value. The staff are recommending confirming that the characteristic of the asset or liability needs to be considered when selecting a relevant measurement basis, but they propose adding more guidance and deleting the reference to variability in cash flows. 

Contributions to cash flows

The ED identified how an asset (or liability) contributes to cash flows as another factor to consider in selecting a measurement basis. The staff noted that a few respondents did not support the idea of referring to business activities. The staff believes that the Conceptual Framework would be enhanced by separating the principle from the supporting discussion. They think it is important to clarify situations in which a cost measurement basis provides more relevant information and cases where current value provides more relevant information, and to explain the rationale for such assessment.

Faithful representation and the enhancing qualitative characteristics

Many respondents agreed that the qualitative characteristic should be considered in the selection of a measurement basis. There were no major concerns on this area.

Recommendation

The staff is recommending that the measurement chapter (under the heading of current value); state that the characteristic of the asset or liability and the contribution it makes to future cash flow need to be considered when selecting a relevant measurement basis; and retain the discussion in the ED if faithful representation.

The staff noted that these recommendations are consistent with the ED.

Discussion

The Board approved the staff recommendations related to current cost and faithful representation.

On the other hand, the Board did not approve the recommendations on the factors to consider in selecting a measurement basis using the variability of value and how it contributes cash flows.

On variability, there was general disagreement with deleting the notion of variability in cash flows because this is relevant for financial instruments. There were concerns about providing examples rather than giving clearer concepts. It was suggested that the language needs to be softened so as not to drive a list of items that should follow specific measurement criteria. Board members also said that the definition does not help when variability and how an asset contributes to cash flows conflict.

The staff agreed to present a new paper to better articulate the criteria, which would explain the relationship with IFRS 9, and no examples would be included.

In relation to the contribution to cash flows, there were similar concerns raised by the Board. In addition, the Board members stated that (i) the criteria did not distinguish between assets that contribute directly or indirectly to generate revenue—the wording seemed confusing because it refers to “revenue generating” whereas all assets and liabilities contribute directly or indirectly; (ii) the definition does not fit some financial instruments because financial assets are designated for particular purposes and is difficult to apply the concept of “revenue generating”; (iii) the concept of producing goods and services seemed quite narrow and did not capture other revenue generating transactions; and (iv) there was no single factor that could lead to a particular measurement (i.e. having separate discussion topics did not seem helpful)

The staff agreed to re-draft the agenda paper which would focus on high level criteria instead of individual criteria; and would add a discussion of financial instruments.

The staff will redraft those sections and bring it back at a future meeting.

Next steps

At the next meeting the staff would bring papers on (a) asymmetric treatment of gains and losses; (b) the reporting entity and going concern assumptions; (c) the definition of equity; (d) derecognition; (e) remaining aspects of the measurement chapter; (f) presentation and disclosure; (g) capital maintenance; (h) materiality; and (i) business activities and long-term investment.

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