The IASB continued its discussion of the comments received on the Conceptual Framework exposure draft (the ‘CF ED’). The topics for this meeting were as follows:
In addition, the tentative decisions made to date are summarised in AP 10A. APs 10C and 10D contain the suggested revised draft of the relevant sections of Chapter 6—Measurement in clean and marked-up forms respectively.
The Staff intends to discuss the following topics in the January 2017 Board meeting: (a) factors specific to initial measurement; (b) more than one relevant measurement basis; and (c) the Exposure Draft Updating References to the Conceptual Framework.
Conceptual Framework: Measurement — Redrafting the factors to consider in selecting a measurement basis — Agenda paper 10B
At its September 2016 meeting, the Board discussed a revised draft of various sections of Chapter 6–Measurement of the CF ED at an educational session (see AP 10H to that meeting). Based on feedback received from that meeting, as well as comments received from the Accounting Standards Advisory Forum meeting held in September 2016, the Staff has made further changes to the Measurement chapter of the CF ED.
The purpose of this session is to ask the Board for their views on the revised draft. The Board will not be asked to approve the revised draft at this meeting.
The Staff proposes making the following changes to the Measurement chapter of the CF ED:
- Adding a paragraph in the ‘Introduction’ section to provide the Board with an appropriate degree of freedom in selecting measurement bases when developing new Standards.
- Removing the discussion on customisation of value in use and fulfilment value, as well as risk premiums and their reversals. This is because the Staff thought that these could be more appropriately dealt with in the development of individual Standards rather than in the CF.
- Dividing the section titled ‘Measurement bases and the information that they provide’ into two sections:
- Measurement bases. This provides a brief description of the various measurement bases, being historical cost and current value. Current value encompasses fair value, value in use and fulfilment value, and current cost; and
- Information provided by different measurement bases. The revised draft expands significantly on the conceptual basis of historical cost; clarifies discussions on fair value and current cost to reduce chances of misinterpretation and to make the analyses more comprehensive; as well as highlights the differences in the information provided by the different measurement bases.
- Retaining the discussion of current cost, but repositioning it as part of the discussion of current values (see (c)(i) above).
- Extensively revising the ‘Factors to consider when selecting a measurement basis’ section by:
- Adding guidance on how the relevance of a measurement basis for an asset or a liability and the related income and expenses is affected by (1) the characteristics of that asset or liability, and (2) how that asset or liability contributes to future cash flows
- Repositioning the discussion of measurement uncertainty from the ‘relevance’ section to the ‘faithful representation’ section; and
- Grouping the discussion of the implications of the enhancing qualitative characteristics of comparability, verifiability and understandability, as well as cost constraints, for each measurement basis under the heading of ‘enhancing qualitative characteristics and the cost constraint’. Furthermore, adding a discussion on why the application of current cost can be complex and subjective.
The Board was generally happy with the revised draft of the measurement chapter. The Staff will proceed with drafting a version for balloting purposes taking into account the comments received during the meeting.
The Board made the following observations:
- The use of words ‘proxy measurement basis’ and ‘modifying a measurement basis’ in paragraph 6.4 appeared to blend different variations of measurement bases together, which was inconsistent with the distinct measurement alternatives that the Board was hoping to provide in the CF. The Board suggested redrafting the paragraph to distinguish the measurement bases from the techniques on how to achieve those measurement outcomes.
- There was significant discussion on how the fulfilment value should be customised to make it entity specific (even though the Board generally agreed with removing the related discussions from the ED), including what cash flows and discount rate should be used and how the market rate should be determined and used as an input in arriving at the entity-specific discount rate. Some Board members suggested clarifying the difference between fulfillment value and fair value.
- The Board had serious concerns with the redrafted historical cost section. The revised draft stated that the use of historical cost was justified for a recently acquired asset. The Board believed that this was a feeble conceptual basis for the use of historical cost, and that people might misconstrue the paragraph as implying that historical cost was relevant to recently acquired assets only, that it might not be appropriate for long-lived assets, and that a change in measurement basis might be required when the asset was no longer recently acquired. The Board suggested that the CF (i) establish a solid conceptual basis for historical cost (e.g. that it was relevant for the purpose of allocating costs over the periods during which an asset was used and explaining its relevance in terms of the accrual basis of accounting, and that it represented profits realised from an entity’s operating activities), and (ii) provide a balanced discussion of the shortcomings and merits of historical cost , including the fact that there were valid reasons to use historical cost in different circumstances; however, it had shortcomings which might be overcome by the use of current values. In this case, each of the bases remained valid and relevant even though they provided different perspectives on the same economic situation.
- The CF should also discuss the shortcomings of fair value, as well as contextualising the whole fair value discussion in terms of the market(s) to which the entity has access in order to be consistent with IFRS 13.
Factors to consider when selecting a measurement basis
- Various paragraphs in the revised draft gave the impression that amortised cost might be used when the cash flows of a financial asset/liability comprised more than principal and interest. One Board member was strongly of the view that this was inconsistent with how IFRS 9 defined amortised cost and suggested that the offending paragraphs be redrafted.
Conceptual Framework: Business activities and long-term investment — Agenda paper 10E
Respondents to the ED agreed that the nature of an entity’s business activities plays a role in financial reporting. However, the respondents were divided as to how overarching that role should be and how much guidance should be included in the CF. Most respondents agreed with the extent of discussion about the implications of long-term investment for standard-setting. However, given that the ED did not specifically address the measurement of long-term assets and long-term liabilities and the presentation of income and expenses arising from those items, some respondents requested more guidance in this regard.
In relation to business activities, the Staff notes that the feedback received on the ED was consistent with that on the Discussion Paper, which means that the feedback does not provide the Board with any new input that could cause the Board to reconsider the proposed approach. Specifically, the Staff disagrees with respondents’ comments that a consideration of an entity’s business activities would impair comparability of the financial statements, or that it should be introduced as an overarching concept in making decisions about the unit of account, measurement, and presentation and disclosure. This is because the Staff believes that an entity’s business activities are a matter of fact and that the proposed approach would result in similar business activities being considered in the same manner when deciding how items should be reflected in the financial statements (thus ensuring comparability). Furthermore, the Staff believes that different weights should be given to business activities and other considerations in different circumstances, and hence it would be inappropriate to make business activities (as opposed to other considerations) an overarching concept.
As regards long-term investments, the Staff notes that the revised CF as presented in APs 10B to 10D above contains sufficient guidance on how the Board should consider the nature of an entity’s business activities and how a particular asset or liability will contribute to the entity’s cash flows when selecting a measurement basis. Furthermore, the revised CF already gives the Board the ability to require presentation of particular changes in current values in OCI if the Board concludes that doing so would enhance the relevance or faithful representation of information for a particular business activity. Accordingly, the Staff recommends that no specific changes be made in this regard.
The Staff recommends that the Board confirm the approaches to business activities and to long-term investment as proposed in the ED. Specifically, the revised CF:
- will discuss how the way in which an entity conducts its business activities may affect decisions about the unit of account, measurement, and presentation and disclosure; however, the CF will not introduce business activities as an overarching concept that affects all areas of financial reporting;
- will not comment on long-term investment as a business activity because discussion of implications of any particular type of business activity is most appropriately dealt with in individual Standards, rather than generically in the CF;
- will not include specific measurement or presentation concepts relating to long-term investment because the CF will provide sufficient concepts for the Board to make appropriate Standard-setting decisions on measurement and presentation, including decisions for long-term investments; and
- will not include any further discussion of information needs of long-term investors because the CF will provide sufficient concepts for the Board to address the needs of all primary users of financial statements, including long-term investors.
The Board unanimously approved the Staff’s recommendations. Nothing major came out of the discussion – only one minor improvement was suggested.
Conceptual Framework: Concepts of capital and capital maintenance — Agenda paper 10F
The ED carries forward the chapter on capital and capital maintenance from the existing Framework substantially unchanged. This is because the Board intends to revise the discussion of capital and capital maintenance if it were to carry out future work on accounting for high inflation, and no such work is currently planned.
Almost all respondents who commented on this chapter took issue with this approach. They considered the existing chapter to be inadequate, outdated, and inconsistent with the rest of the proposals in the ED (see appendices A and B to the agenda paper). Some respondents believed that the chapter should be excluded until the Board considers the topic more comprehensively; whereas others believed that the concepts of capital and capital maintenance are fundamental to financial reporting and thus the CF should include such a chapter, but that it should be updated.
The Staff acknowledges the concerns raised by respondents. However, the Staff believed that it would be inappropriate to exclude the discussion of capital and capital maintenance altogether from the CF. This is because those concepts interact with the objective of financial reporting, the definitions of income and expenses, the selection of measurement bases and presentation and disclosure decisions. Likewise, the Staff also believes that it is not feasible to update the discussion at this stage, taking into account the time that would be needed to develop and re-expose the revised concepts and the fact that the respondents expressed diverse views on how that discussion should be updated, which would significantly delay the completion of the CF project.
As an alternative, the Staff believes that the Board could clearly indicate at the start of the capital and capital maintenance chapter that it has not been updated in the CF project. This follows the precedent set when the Board issued revised Chapters 1 and 3 of the Conceptual Framework in 2010 where it carried forward the existing Introduction and the remaining chapters of the Framework.
The Staff recommends carrying forward the existing chapter on capital and capital maintenance to the revised CF, with a statement in the body (as opposed to in the Basis for Conclusions) to explain that the chapter has not been updated in the CF project.
The Board agreed with the Staff’s recommendation.
The Staff updated the Board on the ASAF’s discussion in December 2016 on this matter saying that all ASAF members agreed that capital maintenance was a very important concept in financial reporting. However, the ASAF members were divided as to whether the existing chapter should be included in the revised CF for the same reasons explored in the agenda paper.
The Board debated the pros and cons of various alternatives but on balance, the Board generally supported inclusion of the existing chapter and that the introductory statement should explain why the Board had kept it but had not updated it.
Conceptual Framework: Derecognition — Agenda paper 10G
Paragraph 5.26 of the ED explains that the accounting requirements for derecognition aim to represent faithfully both:
- the assets and liabilities retained after the transaction that led to the derecognition; and
- the change in the entity’s assets and liabilities as a result of that transaction.
Paragraph 5.27 of the ED states that those aims are normally achieved by:
- derecognising any assets or liabilities that have been transferred, consumed, collected or fulfilled; and
- continuing to recognise the assets or liabilities retained, if any.
This is referred to as the ‘default derecognition requirement’ in the AP.
Paragraph 5.32 of the ED goes on to say that if the default derecognition requirement (simply put, derecognising the asset/liability) is not sufficient to achieve both aims of derecognition, then there may be a need to continue recognising the transferred component.
No respondents disagreed with the two aims of derecognition in paragraph 5.26. However, with regard to the approach to derecognition as described in paragraphs 5.27 and 5.32, some respondents thought that the Board had adopted a combination of a control approach and a risks-and-rewards approach and they suggested that the CF adopt a single approach (with a preference for a control approach) to derecognition that would apply in all circumstances. Other respondents stated that if the CF does not require a single approach in all circumstances, then it should provide more guidance on which approach would be more appropriate under which circumstances.
Modification of contracts
The ED states that whether the rights and obligations that are added by a modification of a contract should be treated as part of the same unit of account as the existing rights and obligations will depend on whether they are distinct from those created by the original terms of the contract. Some respondents commented that the use of the term ‘distinct’ without defining it might be confusing because it is used in various ways in existing Standards.
The Staff notes that the respondents have misunderstood the proposed derecognition approach, and clarifies that:
- the ED proposes a default derecognition requirement that would normally meet both aims of derecognition.
- the default derecognition requirement is based on whether an item continues to meet the definition of an element. However, the ED does not label this as the control approach, because that label would put emphasis only on one of the two aims of derecognition.
- the ED accepts that there might be cases when continued recognition might best meet the two aims of derecognition. However, such a proposal is not the same as a risks-and-rewards approach. This is because a risks-and-rewards approach would require continued recognition until the entity is no longer exposed to the risks and rewards of the asset or liability. However, the ED does not discuss when derecognition of assets or liabilities that are the subject of continued recognition should ultimately occur.
- it therefore follows that the ED is not a combination of the control approach and risks-and-rewards approach either.
Despite the above, the Staff believes that the ED does not preclude the risks-and-rewards approach as a valid application of the derecognition proposals in the ED in response to concerns raised for the derecognition of financial assets.
In response to the suggestions that the CF should adopt a single derecognition approach that would apply in all circumstances, the Staff notes that the ED already includes detailed explanations of why in some circumstances, e.g. when an entity disposes of only part of an asset or a liability and retains some exposure, it might be difficult to achieve the two aims of derecognition by applying the default derecognition requirement, which is why there may be a need to continue recognising the transferred component of an asset or a liability. The basis for conclusions includes examples of these situations and why derecognising the assets in those cases might not faithfully represent the economics of the transactions. The Staff notes that the respondents supporting the adoption of a single derecognition approach did not demonstrate how that approach would alleviate the concerns identified by the Board in these examples.
The Staff believes that the different views to which derecognition approach is appropriate are captured by the two aims of derecognition: one aim focuses on the faithful representation of the retained components, while the other aim focuses on the faithful representation of the changes in the rights and obligations. In the Staff’s view, given that the two aims of derecognition remain appropriate in light of comments received, the most appropriate approach to derecognition will depend on how to best achieve these two aims when they conflict. It would also depend on the measurement basis and the unit of account for the previously recognised item when making decisions at a Standards-level.
Accordingly, the Staff believes that the original proposal of applying the default derecognition requirement as a first step, coupled with the continued recognition of the transferred component when the default recognition requirement is not sufficient to meet the two aims of derecognition, remains valid.
Modification of contracts
The Staff agreed with the respondents and believes that the concepts developed in the unit of account chapter may be more useful for identifying rights and obligations that should be accounted for separately than retaining the notion of ‘distinct’.
The Staff recommends the following:
- confirming the derecognition concepts proposed in the ED; and
- retaining the discussion of contract modifications in the ED. However, when considering whether new rights and obligations that are added by a contract modification should be accounted for as new assets or liabilities, the Staff recommends replacing the notion that those rights and obligation should be ‘distinct’ with a reference to the concepts on the unit of account in the elements chapter.
The Board approved the Staff’s recommendation.
There was a lengthy debate on whether the CF should specifically mention how the default derecognition requirement and the potential need to continue recognising the transferred component would apply to financial instruments.
No other major issues were raised by the Board.