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Conceptual framework

Date recorded:

The IASB will continue its discussion of the comments received on the Conceptual Framework exposure draft (the ‘CF ED’). The topics for this meeting are as follows:

  • Liability definition and supporting concepts—the ‘no practical ability to avoid’ criterion (AP 10C);
  • Liability definition and supporting concepts—reducing the risk of further changes (AP 10D);
  • Liability definition and supporting concepts—other topics (AP 10E);
  • Effects of the proposed changes to the Conceptual Framework on preparers (AP 10G);

In addition, the tentative decisions made to date are summarised in AP 10A. APs 10B and 10F (discussed in the October 2016 Board meeting and reproduced for reference only) provide background information to support APs 10C–10E.

The Staff intends to discuss the following topics in the December Board meeting: (a) derecognition; (b) measurement; (c) capital maintenance; (d) business activities and long-term investment; (e) the Exposure Draft Updating References to the Conceptual Framework; and (f) the review of potential inconsistencies between existing IFRS Standards and the revised Conceptual Framework.

Conceptual Framework - Liability definition and supporting concepts — the ‘no practical ability to avoid’ criterion - Agenda paper 10C

Background

The CF ED proposes that an entity has a present obligation to transfer an economic resource if (a) the entity has no practical ability to avoid the transfer; and (b) the obligation has arisen from past events. Many respondents broadly agreed with the proposal, except banks. Banks expressed concerns about the implications of the ‘no practical ability to avoid’ criterion in classifying financial instruments as liabilities or as equity. Furthermore, many respondents were concerned about the difficulties in interpreting the ‘no practical ability to avoid’ criterion as they believe this will involve substantial subjectivity. The respondents were also divided in their views as to whether, and to what extent, economic compulsion should be considered in assessing whether a present obligation exists. They cite that there could be particular difficulties in judging whether an action to avoid a transfer ‘would have economic consequences significantly more adverse than the transfer itself’—especially if the consequences were unpredictable and assessments were likely to change over time.

Staff analysis

With regard to the banks’ concerns, the Staff notes that the Board is addressing financial instrument classification in the financial instruments with characteristics of equity project (the ‘FICE project’) and that the Board has decided that the concepts in the revised CF will not necessarily limit the range of possibilities explored in that project.

As regards the difficulties in interpreting the ‘no practical ability to avoid’ criterion, the Staff notes that preparers would rarely be required to apply this criterion without further requirements and guidance. This is because the Board would apply this criterion when it is developing Standards for particular transactions, and it could provide additional guidance to reduce the subjectivity involved in identifying liabilities for those transactions.

As regards the economic compulsion issue, the Staff continues to believe that in some circumstances, the economic consequences of taking an action to avoid a transfer may be so adverse that an entity has no practical ability to take the avoiding action in those circumstances. However, the Staff agrees that assessing the economic consequences of avoiding actions may not always be an appropriate and workable basis for determining whether an entity has the practical ability to avoid a transfer. This is especially the case if the economic consequences of the transfer or the avoiding action (or both) are prone to price fluctuations. The Staff further notes that the factors used to assess whether an entity has the practical ability to avoid a particular transfer should depend on the type of transaction under consideration.

The Staff’s analysis indicates that there is no need to amend the CF ED for other issues raised by the respondents.

Staff recommendation

The Staff recommends refining the ‘no practical ability to avoid’ criterion to state that, in order to conclude that an entity has no practical ability to avoid a transfer:

  • (a) the factors considered should depend on the type of transaction under consideration; and
  • (b) it would not be sufficient that the management of the entity intends to make the transfer or that the transfer is probable.

Conceptual Framework - Liability definition and supporting concepts — reducing the risk of further changes - Agenda paper 10D

Background

This paper considers refinements to the CF ED to reduce the risk of including concepts in the CF that may need to change as a result of future decisions on classifying financial instruments arising from the FICE project.

Staff analysis

The Staff identifies the following paragraphs in the CF ED that relate to the classification of claims as a liability or equity:

  • (a) Paragraph 4.33(b) states that if an entity prepares financial statements on a going concern basis, it has the practical ability to avoid a transfer that would be required only on the liquidation of the entity or on the cessation of trading. This statement implies that any present claim that would be settled only on liquidation is an equity claim, which is inconsistent with the approach being developed (Gamma) which classifies an obligation to transfer an amount only on liquidation of the entity as a liability if that amount is independent of the entity’s economic resources.
  • (b) Paragraph 4.30 states that an obligation of an entity to transfer its own equity claims to another party is not an obligation to transfer an economic resource. That statement implies that an obligation for an entity to transfer its own equity instruments never constitutes a liability (even if the obligation requires the transfer of a variable number of equity instruments), which is inconsistent with existing IFRS requirements.
  • (c) Paragraph 4.31 states that an entity has a present obligation to transfer an economic resource if (a) the entity has no practical ability to avoid the transfer; and (b) the obligation has arisen from past events. The Staff notes that the purpose of this paragraph is to help identify when any claim meeting the definition of a liability arises; however, the Staff is concerned that it could be interpreted to mean that any claim that meets these two criteria would be a liability, and could not be an equity claim.

Staff recommendation

The staff recommends amending the CF ED to remove the inconsistencies identified above. The proposed drafting is included in the appendix.

Conceptual Framework - Liability definition and supporting concepts — other topics - Agenda paper 10E

Background

This paper considers feedback on the following issues:

  1. The interpretation of ‘as a result of past events’. Respondents noted difficulties in applying the concept that ‘the entity has received the economic benefits, or conducted the activities, that establish the extent of the obligation’ when assessing what is the event that constitutes the ‘past event’.
  2. Is there a need for both ‘present’ and ‘as a result of past events’ in the asset and liability definitions? Respondents suggested omitting either ‘present’ or ‘as a result of past events’ from the definitions of an asset and a liability on grounds that it is redundant—a ‘present’ obligation (or economic resource) is one that is the result of past events.
  3. Introducing the concept of a ‘present claim’ to the liability definition. The CF ED states that the objective of general purpose financial reporting is to provide ‘… information about the entity’s economic resources and the claims against the reporting entity.’ Some respondents are concerned that by merely referring to claims (as opposed to present claims), the proposed ‘no practical ability to avoid’ criterion of the liability definition might be interpreted as encompassing items that are not present claims, e.g. future asset maintenance costs, future salaries and future operating losses.
  4. Correspondence between assets and liabilities. Some respondents questioned whether the concept in paragraphs 4.25 and 4.26 of the CF that if one party has a liability another party has an asset always holds true. They suggested removing this statement from the CF.
  5. Introducing concepts for non-reciprocal transactions. A few respondents suggested that the CF should include concepts that specifically address non-reciprocal transactions such as donations and income taxes.
  6. Concepts on existence uncertainty. Feedback indicates that there is difficulty in concluding whether a liability exists in certain circumstances, and if so, what is the nature of the liability.

Staff recommendation

Issue 1

The Staff recommends that, to clarify the meaning of ‘as a result of past events’ in the definition of a liability, the CF be revised to:

  • (a) refer to an activity of the entity ‘that will or may oblige it to transfer an economic resource that it would not otherwise have had to transfer’, instead of the activity ‘that establishes the extent’ of the entity’s obligation (as was proposed in the ED).
  • (b) clarify that the enactment of a law (or the introduction of some other enforcement mechanism, policy or practice, or the making of a statement) is not in itself sufficient to give an entity a present obligation. The entity must have conducted an activity to which a present law (or other present enforcement mechanism, policy, practice or statement) applies.

Issue 6

The Staff recommends splitting the discussion of existence uncertainty in the CF ED as follows:

  • (a) the discussion of how existence uncertainty arises should be moved to the concepts on identifying assets and liabilities (Chapter 4);
  • (b) the discussion of the consequences of existence uncertainty for recognition should remain in the concepts on recognition (Chapter 5).

The Staff recommends that no change be made for the other issues based on analyses performed, mostly on grounds that the issues have been considered before, only a few respondents raised the issues, or the respondents did not put forward new arguments to challenge the analyses already provided in the Basis for Conclusions.

Conceptual Framework - Effects of the proposed changes to the Conceptual Framework on preparers - Agenda paper 10G

Background

The Board published Exposure Draft Updating References to the Conceptual Framework in May 2015 which proposes to replace references to the current Framework in Standards with references to the Conceptual Framework (as revised by the proposed CF ED). As IAS 8.11 requires entities to develop accounting policies by reference to the Framework in certain circumstances, this paper analyses the significance of the changes, if any, that might be required to accounting policies developed by reference to IAS 8.11 as a result of the proposed replacement of references.

The Staff will ask the Board for feedback on the analysis performed but will not ask them to make any decisions at this meeting.

Staff analysis

The Staff analysis indicates that the proposed replacement of references in IAS 8 is likely to have a limited effect on preparers’ existing accounting policies because:

  • (a) it is rare for preparers to develop accounting policies by reference to the Framework; and
  • (b) in some areas the revised concepts will result in outcomes that are similar to the existing concepts.

Correction list for hyphenation

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