Annual improvements criteria - comment letter analysis

In August 2010, the Trustees of the IFRS Foundation published for public comment a Consultation Document which sets out a proposal to add new paragraphs to the Due Process Handbook for the International Accounting Standards Board (IASB Due Process Handbook) relating to the annual improvements process.

The proposed amendments to the IASB Due Process Handbook are intended to provide enhanced criteria to assist the IASB and interested parties on determining whether a matter relating to the clarification or correction of IFRSs should be addressed using the annual improvements process.

The staff presented an analysis of the comments received in respect of the proposed amendments, including certain revisions.

The Committee determined that the following amendment was acceptable to the proposed paragraph 65A(a)(ii), since it is not the intention to use annual improvements as a mechanism to expose new exceptions to the application of existing principles:

A correcting amendment does not propose a new principle or change to an existing principle., but may create an exception from an existing principle'

Constituents were confused by the use of "pressing need" in the context of an amendment that was "non-urgent but necessary". Therefore the Committee tentatively proposed the following amendment to paragraph 65A(d):

If the proposed amendment would amend IFRSs that are the subject of a current or planned IASB project, there must be a pressing need to make the amendment sooner than the project would.

The Committee expressed their desire for the Trustees to reassure the constituents that any change to the accounting literature via annual improvements has the same due process as any other. It was agreed that clarifying this would negate the need for certain of the clarifications suggested by constituents, and would clarify that the Board makes the ultimate decision, even if the legwork for an issue has been done by the Committee.

As a result of certain comments raised by constituents, the Committee tentatively agreed to amend the wording in paragraph 24(d) in the IFRIC Due Process Handbook:

The proposed amendment is has a narrow and well-defined and sufficiently narrow in scope such that purpose, ie the consequences of the proposed change have been considered sufficiently and identified.

The Committee discussed the need to clarify the distinction between an annual improvement and an interpretation, with most members being in agreement that additional clarification would help constituents. There was a general agreement that criteria would be useful, but that they should not be so prescriptive as to force an issue to be either an annual improvement or an interpretation, since one of the reasons for sending something to the Committee for consideration is to allow determination regarding the most efficient way for it to be dealt with.

The Committee reached a tentative decision that today's paper should be provided to the Board along with the comments from the Committee. The Board views should then be collated with the paper and the Committee comments, and the combined comments and paper shared with the Trustees in February. When the Trustees review the analysis, it was suggested that they could consider and begin to formulate a view, but leave open for their own consideration until the effectiveness of the Committee has been assessed.

It was also recommended that the Trustees might like to consider performing their review of the effectiveness of the Committee alongside a review of the common areas considered by the Committee in the past, and use the latter to assist in determining the criteria for Committee consideration/interpretation.

The final discussion point related to whether the Committee should issue implementation guidance in respect of financial reporting issues not addressed specifically elsewhere in IFRSs, as a result of a comment received which suggested that this could be interpreted as one of its mandates according to paragraph 43(a) of the constitution. The general consensus within the Committee was that the answer to this should be no', since if the Committee were to start issuing Q&As then they would begin to move toward a more rules-based approach, rather than coming up with clear principles and allowing judgement for implementation.

Agreement of minutes of the last meeting.

The IFRS Interpretations Committee received a request in 2009 for guidance on how to account for stripping costs in the production phase of a surface mine. The Committee took the issue onto its agenda in January 2010, and in August 2010 it published for public comment a Draft Interpretation Stripping Costs in the Production Phase of a Surface Mine. The Committee re-deliberated the previous conclusions reached in light of the comment letters received.

The Committee discussed whether to move forward with the project and tentatively agreed that it should continue with developing this interpretation since there appears to be current diversity in practice, and further diversity in practice is anticipated with additional jurisdictions adopting or expected to adopt IFRS.

It was decided that the concept of "stripping campaign" be abandoned because many thought it would be too difficult to define and could lead to a rules-based interpretation. Instead, the Committee agreed that guidance be developed by the staff to assist in applying the existing cost capitalisation principle in IAS 16. The Committee asked the staff to develop this guidance, along with indicators that would assist in determining whether costs are incurred during the development phase or production phase.

The decision was taken by the Committee to leave it up to the judgement of the entity as to whether the stripping cost asset should be accounted for under IAS 16 or IAS 38. In terms of depreciation/amortisation, the Committee tentatively agreed that the specific identification approach is still valid, but that the guidance should not be too prescriptive and should leave room for judgement based on the identification of the type of ore that's likely to be extracted.

The Committee decided that the drafted illustrative example should be removed, prior to finalising the Interpretation. The Committee agreed to delay discussing impairment testing in respect of stripping costs and transition until a later meeting.

The Committee discussed the tentative agenda decision published in the November 2010 IFRIC Update.

It was noted by the Committee that in practice "risks specific to the liability" in paragraph 47 of IAS 37 generally exclude credit risk and only include the risk of the liability itself.

The Committee therefore agreed to update the previous tentative agenda decision to include commentary to this effect, and to clarify that the republished tentative agenda decision was based on the fact that there is no apparent divergence - either currently or expected in the future - in practice.

The primary issue discussed by the Committee relates to the accounting for the subsequent measurement of the NCI put prior to exercise or lapse. The financial liability recognised for an NCI put with a variable exercise price is updated at each reporting date to reflect current estimates of the exercise price. There is agreement over the need to remeasure the financial liability at each reporting date; the issue leading to diversity in practice is whether that remeasurement should be recognised (a) in profit or loss; or (b) in equity.

The staff from the Financial Instruments with Characteristics of Equity (FICE) project provided a short summary of the project, commenting that reporting the change in earnings would be consistent with the treatment of any other type of derivative. The staff from the FICE project expressed a concern around putting the change through equity since neither US GAAP nor IFRS follow that treatment unless the change is relating to a derivative that is classified in equity. It is likely to be two years until the FICE project will be completed. It was therefore suggested that the Committee might be able to deal with this matter on a timelier basis.

One of the Committee members is currently researching the impact that amending IAS 32 would have, and how extensive these amendments would need to be. The impact of an amendment in IAS 39 to clarify that the NCI put should be accounted for in equity would be less extensive, and is also being considered.

The Committee was unable to reach a consensus as to what current IFRSs require. It was suggested that if the Committee decides on the net approach, then perhaps NCI puts should simply be scoped out of IAS 39 and net accounting be mandated. The staff of the FICE thought that ringfencing would be a good idea if it was considered achievable.

It was tentatively agreed to continue researching this matter. The staff plans to bring papers to the March 2011 Committee meeting with detailed proposals for a short-term solution.

IAS 1 Presentation of Financial Statements - Current/non-current classification of debt (rollover agreements)

A request was received in October 2010 by the IFRS Interpretations Committee, to clarify the meaning of unconditional right to defer settlement' in paragraph 69(d) of IAS 1 Presentation of Financial Statements. This issue was discussed at the Committee's November 2010 meeting, and the Committee asked the staff to perform outreach on the topic in order to understand the level of diversity in practice.

Based on the outreach responses received, it seemed that diversity in practice arose where an existing liability due within 12 months after the reporting date is renegotiated for at least another 12 months, with the same lender at different terms. The staff therefore recommended that paragraph 73 of IAS 1 should be amended as follows:

If an entity expects, and has the discretion, to refinance or roll over an obligation for at least twelve months after the reporting period under an existing loan facility with the same lender, on the same or similar terms, it classifies the obligation as non-current, even if it would otherwise be due within a shorter period. However, when refinancing or rolling over the obligation is not at the discretion of the entity (for example, there is no arrangement for refinancing), the entity does not consider the potential to refinance the obligation and classifies the obligation as current.

The Committee tentatively agreed that the proposed wording is acceptable. It was also tentatively agreed that there should be a cross-reference to the derecognition guidance for financial liabilities (paragraph 40 of IAS 39).

The Committee also agreed with the staff's assessment that the proposed amendment should be made through the Annual Improvements process.

Paper 11A of the Committee meeting in November 2010 discussed whether the assessment of a right as unconditional (as contemplated in paragraph 69 of IAS 1) requires consideration of all possible future circumstances, or only those that exist at reporting date. Specifically, whether there is any reason to believe that the lender providing the long-term finance would not be able to honour facility if called upon. Almost all outreach responses stated that only circumstances up to the balance sheet date (and up to the approval of the financial statements) should be considered, and that assessing the going concern of the lender is not required for purposes of classifying the liability. The staff therefore proposed that the Committee take no action in respect of this issue. All Committee members were in agreement.

IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets - Contingent pricing of PPE and intangible assets

The Committee received a request for guidance on how to account for contingent payments for the separate purchases of property, plant and equipment (PPE) or intangible assets. The purpose of the Committee discussion was to determine whether the issue be taken onto the Committee's agenda and be dealt with through an interpretation.

There was a general consensus within the Committee that the contingent price in a purchase agreement is an element of the cost of the asset purchased although some Committee members acknowledged there may be situations where the contingent payment would not be an element of the cost of the asset (for example, if the contingent event is completely unrelated to the purchased asset).

The Committee also generally agreed that the contingent price should be recognised as a financial liability only to the extent that the buyer does not have control over the realisation of the event that triggers the contingent price. However, the distinction was made between having theoretical control and the fundamental assumption that a buyer would have rational economic intentions (for example, if a contingent price was based on the level of production - despite the buyer being able to control production and therefore, in theory, being able to control the contingent price, any rational buyer would want to maximise profits and therefore wouldn't decrease production simply to avoid the contingent payment). The Committee agreed that rational economic intentions would underpin the determination of control.

As set out in Agenda paper 10, there are two views in respect of accounting for subsequent changes in the financial liability:

• View 1: the subsequent changes in the financial liability are the remeasurement of a financial liability and are independent of the asset. Accordingly, the remeasurement should not be adjusted against the carrying amount
• View 2: the subsequent changes to the amount payable represent changes to the cost of the asset. Therefore adjustments should be reflected as increases or decreases to the carrying amount of that asset under the cost model.

There was general agreement that if the contingent payment meets the definition of an asset in IAS 16/IAS 38 then the amount should be recognised as a part of cost of the asset. However, the conflict with IAS 39 was also specifically acknowledged, which it was suggested could be dealt with by amending the literature.

One Committee member suggested that contingent consideration should be dealt with in the same way as IFRS 3 (2008): i.e. Cost = Purchase Price + Fair Value of Contingent Consideration. Any subsequent changes to the value of contingent consideration should then go to profit or loss, which would avoid conflict with IAS 39. There was some level of support for this suggestion within the Committee, although it was noted that this would lead to a cost based on an estimate that is not to be corrected for future events.

The staff's preliminary assessment of the agenda criteria is as follows:

(a)	The issue is widespread and has practical relevance. The issues described in this document are widespread and are of practical relevance.
(b)	The issue indicates that there are significantly divergent interpretations (either emerging or already existing in practice). The Committee will not add an item to its agenda if IFRSs are clear, with the result that divergent interpretations are not expected in practice. There are currently differing views as to how to account for contingent prices upon initial recognition and for subsequent changes, which lead to different treatments.
(c)	Financial reporting would be improved through elimination of the diverse reporting methods. Financial reporting would be improved by clarifying this issue. The accounting for contingent price arising from the purchase of separate items of property, plant and equipment (IAS 16) or intangible assets (IAS 38) is outside the scope of IFRS 3. An appropriate interpretation from the IFRS Interpretations Committee would enhance comparability among companies' financial reporting.
(d)	The issue can be resolved efficiently within the confines of existing IFRSs and the Framework, and the demands of the interpretation process. The issue is sufficiently narrow in order to be addressed by an interpretation of the IFRS Interpretations Committee.
(e)	It is probable that the Committee will be able to reach a consensus on the issue on a timely basis. Although there is a lack of guidance, the staff believe the solution proposed is consistent with current IFRS literature. Therefore, at this stage of the analysis the staff does not foresee any major reason why the Interpretations Committee should not reach a consensus on a timely basis.
(f)	If the issue relates to current or planned IASB project, is there a pressing need for guidance sooner than would be expected from the IASB project? (The IFRIC will not add an item to its agenda if an IASB project is expected to resolve the issue in a shorter period than the IFRIC would require to complete its due process). The issue does not relate to a current Board project.

The Committee agreed that the issue meets the agenda criteria, but summarised that there are a number of other related issues to be considered, namely:

• What does cost mean? What are the components of cost to be included?
• In respect of the timing of recognition:
  • Are analogies to IFRS 3 / IFRIC 1 appropriate (whereby an estimate is made when the acquirer gets control of the asset)?
  • A liability is not recognised in situations under the control of the acquirer?
• If one route is determined as preferable and therefore it is deemed that the acquirer doesn't account for the financial liability in accordance with IAS 39 - should this be treated as an exception?
• If an approach was determined which is not entirely consistent with the current business combinations literature, will this maintain the tension in respect of knowing when a bundle of assets are not considered a business?

The Committee members agreed to submit particular examples to the staff, in order to assist them in their analysis. It was tentatively agreed to restrict the consideration to PP&E only at this stage, since otherwise the extent of the issue will be too great for the Committee to deal with as an interpretation.

The Committee requested the staff provide an analysis at the next meeting which describes the issues that the Committee should be addressing, and describes the scope of the paper. The Committee also requested that the staff look at divergence in practice and consider different approaches (although it was requested that choices should be limited).

The Committee tentatively agreed to add this issue to its agenda.

The staff summarised the submissions that have been received and will be discussed at a future meeting (refer Agenda paper 9).

The staff communicated that the first chapter of the Conceptual Framework for Financial Reporting replaced the objectives of financial statements from the old framework with the objectives of financial reporting. As a result, IAS 1 will likely require amendment. The staff has prepared proposed wording to amend IAS 1 as a part of the Annual Improvements. The Board is due to discuss the proposed amendments in two weeks time. Once the Board has discussed, the proposed amendments will be sent to the Committee for comments.