Use of OCI for the presentation of unearned profits

ASBJ Presentation

The ASBJ raised the question as to whether it is appropriate to present the CSM (which represents the insurance contract’s unearned profit) in the liability section, when considered in the context of the discussion of the Conceptual Framework. The IASB had tentatively decided that the definition of a liability should be largely unchanged, which is ‘a present obligation of the entity to transfer an economic resource as a result of past events’. The ASBJ’s understanding is that an entity does not have an obligation to transfer unearned profits to third parties.

In the ASBJ’s view the CSM can be viewed as the difference between the measurements relevant to the reporting the entity’s financial position and those that are relevant to reporting its financial performance. The ASBJ paper proposes that a logical conclusion of these arguments is that the CSM should be accounted for as OCI and presented as AOCI in the statement of financial position. The CSM presented as AOCI should then be reclassified to profit or loss over the coverage period in a rational way. As the nature of the CSM would not significantly differ between participating contracts and non-participating contracts, this AOCI presentation should be applied to both types of contract.

The ASBJ presentation stated that comprehensive income is the change in net assets except for those items resulting from transactions with owners in their capacity as owners, whereby the recognised assets and liabilities are measured using measurement bases that are relevant from the perspective of reporting the entity’s financial position. Profit or loss is the change in net assets during a period, whereby the recognised assets and liabilities are measured using measurement bases that are relevant from the perspective of reporting the entity’s financial performance. OCI is the ‘linkage factor’ that is used when the measurements that are relevant to reporting the financial position differ from those that are relevant to reporting the entity’s financial performance. Profit or loss should represent an all-inclusive measure of irreversible outcomes of an entity’s business activities.

IASB Staff Response

Under the model proposed by the IASB, the CSM does not represent an obligation to transfer unearned profit. Rather, it is one component of the measurement of the insurance contract liability. The resulting measure depicts the obligation to transfer economic benefits created by the insurance contract as a whole, and accordingly meets the definition of a liability in the current and proposed versions of the Conceptual Framework.

Both IAS 1 Presentation of Financial Statements and the forthcoming Conceptual Framework ED stipulate that profit or loss and OCI are sources of information about performance for the period. The IASB concluded that the CSM on initial recognition is not income, but represents the obligation to provide services under the contract.

Incorporating the CSM in equity is inconsistent with IFRSs, which define equity as the equity holders’ residual interest in the entity. The CSM is not attributable to equity holders because it has not yet been earned.

The forthcoming Conceptual Framework ED will highlight an inconsistency with the ASBJ proposal to use the definition of profit or loss as the irreversible outcomes of the insurer’s business activities. The application of the ASBJ proposal will also be difficult to apply to insurance contracts given that services are delivered without full elimination of the associated uncertainty. In addition, the approach proposed by the ASBJ is inconsistent with other IFRSs, e.g. IFRS 9, that require an entity to recognise in profit or loss (for certain financial assets) gains and losses that may reverse over time.

Discussion during meeting

Several ASAF members stated that they supported the Staff’s views but these were not exactly consistent with the proposed Conceptual Framework, as this could be interpreted in different ways, and should therefore be changed.

It was suggested that the CSM should be defined as a liability, and it was noted that this was recognised as a liability by many insurance companies (for example the Chinese accounting standard on insurance contracts has adopted a similar approach to the CSM).

Several ASAF members expressed the view that it was important for the new insurance contracts Standard to be issued as soon as possible.

Transition to the new insurance Standard

The IASB asked for input from ASAF members on the following issues:

Mandatory effective dates

• What should be the minimum period of time between the mandatory effective dates of IFRS 9 and the new insurance contracts Standard?

Transitional relief: Reassessment of business model

• How should the IASB specify the financial assets to which the reassessment of business model would apply and why?
• Should the reassessment of business model be mandatory or optional?
• When there is a change in the financial assets’ classification as a result of reassessing the business model, should such a change be applied prospectively or retrospectively; and where should any resulting gains or losses be recognised?
• What disclosures should be required when there is a change in the financial assets classification as a result of reassessing the business model?

There are four alternatives transition relief scopes, which are:

a)      All financial assets

b)      Financial assets that are contractually linked to insurance contracts

c)      An entity would need to identify the financial assets related to its insurance business

d)      An entity would make a one-time designation of financial assets related to its insurance business.

For some entities the cost of reassessing the business model may outweigh the benefits. However, requiring the reassessment would increase comparability and consistent application, and be consistent with the transition approach proposed for the new insurance contracts Standard and with IFRS generally, because it reduces options. On the other hand, making the reassessment optional would allow the entity to decide whether the costs would outweigh the benefits. This flexibility becomes more important the greater the number of financial assets that are eligible for the transition relief.

A prospective change in the asset accounting approach would be consistent with the reclassification requirements of IFRS 9, whereas a retrospective change would be consistent with the transition requirements of IFRS 9 and of the new insurance contracts Standard. Presenting any resulting gains or losses in profit or loss would be consistent with the transition requirements from a change in business model in IFRS 9, whereas presenting these in retained earnings would be consistent with the transition requirements of IFRS 9 and of the new insurance contracts Standard.

Discussion during meeting

The Staff stated that some constituents had asked the IASB to consider creating a longer period between the mandatory implementation dates of IFRS 9 and the new insurance contracts Standard given the possible need to reassess the business model.

One of the ASAF members stated that a large number of European constituents wanted the IASB to reconsider its tentative decision in order to avoid the potential need to make two major changes in the accounting for financial instruments within a year or two because such changes would make it more difficult for users to interpret insurers’ financial statements.

Several ASAF members expressed concern at the prospect of having to develop systems to account for the impairment model for assets measured at amortised cost, which may only be needed for a year or two. This would result in considerable cost without any significant benefits.

An IASB member commented that if the IASB were to change its tentative decision on this matter, he would prefer the wholesale deferral of IFRS 9 by insurers rather than tinkering with this IFRS 9. Several ASAF members supported this view. The same IASB member noted that this was a huge incentive to finish the insurance contracts Standard as quickly as possible, but the IASB needed to give further thought to the implementation date of IFRS 9 by insurers.

Of the four alternatives for which assets the transition relief could apply the general view was that option (a) resulted in a definition that was too wide, whereas option (b) was too narrow, with a majority preferring option (c), and a mandatory reassessment of the business model when IFRS 9 is adopted by insurers. The Staff confirmed that this would be a ‘fresh start’ as if IFRS 9 had not previously been adopted.

The Staff asked the ASAF members to email their answers to the remaining questions.