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Research project on discount rates (education session)

Date recorded:

Recap

In this educational session, the staff has updated the IASB on their findings regarding:

  • present value measurement methodology, in particular relating to tax;
  • presentation and disclosures relating to present value measurement;
  • present value measurement objectives and how they explain the differences in discount rates; and
  • scope of present value measurements in IFRS.

In these areas, the staff have identified the following financial reporting problems:

  • the methodology for reflecting tax in measurement can be misunderstood and unclear, leading to material effects and additional implementation costs;
  • inconsistent use of other comprehensive income and profit or loss relating to present value measurements makes comparisons difficult;
  • inconsistent disclosure requirements hamper comparisons;
  • there is a lack of clarity of measurement objectives in individual Standards; and
  • not discounting deferred tax impairs comparability, and it can have a material effect.

Methodology for reflecting tax in measurement can be misunderstood and unclear leading to material effects and additional implementation costs

The staff have identified three issues in this area:

  1. The meaning of pre-tax rate is not clearly explained in IFRS and can lead to using a pre-tax rate from an instrument that is taxed differently which leads to misstatement. The issue is no different from reflecting risk from an instrument that has a different risk profile.
  2. Conversion from pre-tax to post-tax rates and vice versa is not always straightforward and taking shortcuts could lead to errors.
  3. Requirement to only use pre-tax inputs in IAS 36 is burdensome for preparers and does not seem to be necessary. As there is no unwinding of discount, any method used would achieve the same outcome. IFRS 13 is the only Standard that explicitly allows use of either pre-tax or post-tax inputs.

Inconsistent use of other comprehensive income and profit or loss relating to present value measurements makes comparisons difficult

The staff have identified that changes in discount rates and changes in cash flows are recognised inconsistently between pensions, provisions and insurance contracts. Furthermore, the unwinding of discount is not always recognised as interest cost and if it is, different terms are used.

Inconsistent disclosure requirements hamper comparisons

The staff have examined different disclosure requirements for fair value, IAS 19, IAS 36, IAS 37 and the latest proposals on insurance contracts.

The following disclosures were not consistently required for all Standards:

  • discount rate used;
  • profit and loss effect in the period;
  • sensitivity analysis for assumptions;
  • comparatives; and
  • methods used.

There is a lack of clarity of measurement objectives in individual Standards

The staff have found that measurement objectives in individual Standards are different and explain some of the differences in discount rates. However, two issues have been identified.

  1. IAS 19 lacks a measurement objective and the rule-based guidance seems incompatible with any objectives.
  2. The IAS 37 measurement objective is unclear leading to different interpretations, including whether to include own credit risk in measurement.

Not discounting deferred tax impairs comparability and can have a material effect

A measurement based on past or future cash flows that does not reflect the time value of money is not comparable to a measurement that does. Yet, IFRS does not currently require the time value of money to be reflected in the measurement of deferred taxes.

Purpose of the meeting

The discussion is part of the development of a, possible, research paper on discount rates.  The Board has been discussing the research undertaken by the staff in a series of similar sessions and providing feedback on whether they think it documents issues associated with discount rates in an appropriate way.

As such, the Board is not being requested to make any technical decisions at this point.

Board discussion

Before touching on the technical issues of the agenda paper, the Director of Research confirmed that a first screening of responses to the 2015 Agenda Consultation revealed that discount rates were still a very high priority for constituents

Regarding general issues, one Board member proposed to clarify that the financial reporting problem of IAS 36 was not only related to value in use but also to fair value less cost to sell, even if the latter was mostly covered by IFRS 13.

Regarding the question of how risk should be reflected, one Board member said that adjustments to the cash flows or the rates might be overly simplistic. He proposed deeper analysis and research in this area. He would be interested in how preparers adjusted for risk under the current guidance.

Methodology for reflecting tax in measurement can be misunderstood and unclear leading to material effects and additional implementation costs

The Senior Technical Manager presented an example that was handed out during the meeting. The example showed that the sum of pre-tax cash flows and tax cash flows discounted by the post-tax rate delivered the same result as post-tax cash flows discounted by the post-tax rate. Several Board members disagreed with the example and a lively discussion ensued. Many of the issues raised by the Board members related to the actual numbers of the example. As a consequence, the Executive Technical Director proposed to address issues regarding the example outside of the Board meeting. Some Board members disagreed with that approach. As a compromise, the Board agreed that the example should be revised and brought back at a later Board meeting. One Board member said that the example should distinguish between different kinds of measurement (e.g. value in use, bond-like instruments, etc.).

As regards pre-tax vs. post-tax, one Board member stated that preparers should take the rate that is easier to observe. The Senior Technical Manager replied that although pre-tax was in theory easier to observe, preparers would often derive pre-tax rates by artificially adjusting post-tax rates.

Inconsistent use of other comprehensive income and profit or loss relating to present value measurements makes comparisons difficult

One Board member suggested moving this topic to the primary financial statements project. As regards the pensions issue, one Board member said that the Standard was clear that the unwinding of discounting was interest expense. The Senior Technical Manager confirmed that, however the presentation guidance in IAS 1 was very high level which led to diversity.

Inconsistent disclosure requirements hamper comparisons

One Board member disagreed with the indication in the agenda paper that a reconciliation of opening to closing balance was not applicable for IAS 36. In his view, it was applicable as the value in use could potentially be reconciled from opening to closing balance. Several Board members replied that this was a matter for IAS 16 rather than IAS 36 as it would be a reconciliation of the carrying amount of property, plant and equipment instead of a reconciliation of value in use. After a short discussion, the Board member was still of the view that reconciliations were applicable for IAS 36 but agreed that they were covered elsewhere.

Not discounting deferred tax impairs comparability and can have a material effect

One Board member thought that discounting deferred tax was outside the scope of the project as it was a deliberate decision at that time and not an oversight. She said that any revision of this decision should only be done in a dedicated IAS 12 project. Several Board members agreed with one stating that the scope of the discount rates project was already too wide. The Vice Chairman said it had been a practical decision not to discount deferred taxes but that he did not see why it could not be addressed in the discount rates project. A Board member said that it was not operational in practice to time the cash flows arising from deferred taxes. To mandate the discounting of deferred taxes would lead to much higher costs for the preparers which did not outweigh the benefits.

No decisions were made.

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