Improvements - Remaining Issues

Date recorded:

IAS 21

The Board discussed:

  • The level to which goodwill should be allocated for foreign currency translation purposes; and
  • The guidance that should be provided on goodwill allocation issues. The staff recommended the following wording to be added to the Basis for Conclusions: "The Board was persuaded by the reasons set out in paragraph BC29 and decided that goodwill is treated as an asset of the foreign operation and translated at the closing rate. Consequently, that goodwill should be allocated to the level of each functional currency of the acquired foreign operation. Accordingly, the level to which goodwill is allocated for foreign currency translation purposes may be different to the level at which the goodwill is tested for impairment. Entities should follow the requirements in IAS 36 Impairment of Assets to determine the level at which goodwill should be tested for impairment." The Board agreed and consequently no additional guidance will be provided on goodwill allocation. IAS 32 and 39 The Board considered a proposal that a financial instrument be classified as an equity instrument rather than a financial liability only if both conditions (a) and (b) are met:
    • (a) The instrument includes no obligation:
      • (i) to deliver cash or other financial assets; or
      • (ii) to exchange financial assets or financial liabilities under conditions that are potentially unfavourable to the entity.
    • (b) If the instrument will or may be settled in the entity's own equity instruments, it is:
      • (i) a non-derivative that includes no obligation for the entity to deliver a variable number of its own equity instruments; or
      • (ii) a derivative that will be settled by the entity exchanging a fixed amount of cash or of other financial assets for a fixed number of its own equity instruments (other than its own equity instruments that are themselves contracts for the future receipt or delivery of equity instruments)
    The Board agreed subject to some points of clarity. It was noted that similar amendments would be made to the definitions of financial assets and financial liabilities. The Board had previously tentatively agreed to clarify guidance for determining fair value in inactive markets by stating that the best evidence of the fair value of a financial instrument at initial recognition is the transaction price (that is, the fair value of the consideration given or received) unless the fair value of that instrument is evidenced by comparison to other observable, current market transactions or is based on a valuation technique whose variables include only data from observable markets. This decision has been questioned but the staff recommended that the decision be confirmed. The Board agreed to converge the wording in this regard to US GAAP. The Board considered whether to stipulate the requirement for prospective effectiveness testing in the Standard by:
    • emphasising that a hedge qualifies for hedge accounting only if it is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk; and
    • specifying that 'the highly effective' prospective effectiveness test is passed if expected effectiveness is in the range of 80 to 125 percent (that is, the same test that IAS 39 requires for assessing whether a hedge has been effective retrospectively).
    A number of Board members disagreed with allowing an expectation of 80 to 125 percent effectiveness for the prospective test, arguing that it is not sufficiently regorous to justify hedge accounting. The Board agreed to revert to the exposure draft wording - an expectation that the changes in the fair value or cash flows of the hedged item will be "almost fully offset" by the changes in the fair value or cash flows of the hedging instrument. The staff noted that there is no guidance on the recognition of income on a financial asset that either fails to obtain derecognition or is measured under continuing involvement. Similarly, there is no guidance on the recognition of interest or other expense on the associated liability. The staff proposed guidance based on the premise that the entity is continuing to recognise (all or some of) the asset. The logical extension of this principle is that the entity should also continue to recognise the income arising from (all or some of) the asset, and simultaneously recognise an expense for the associated liability. The Board agreed. The Board agreed to clarify that where individual items have been tested for loan impairment, the individual items have a different weighting when tested as part of a portfolio. The Board also agreed that retrospective application of derecognition on initial recognition would be permitted provided the necessary information is available. IAS 16 The SEC has expressed concern that there is potential circularity between the commercial substance provisions of IAS 16 and the 'business purpose' doctrine applied for tax accounting in the United States. Under the valid business purpose doctrine, a transaction is not to be given effect for tax purposes unless it serves a legitimate business purpose other than tax avoidance. The SEC's concern is that an entity may assert that the business purpose for structuring a transaction is to get commercial substance treatment (ie fair value accounting) under financial reporting even though the only thing supporting the commercial substance is the change in tax cash flows. In other words, the financial reporting and tax treatments are co-dependent. FASB agreed to include wording in the Basis for Conclusions to APB 29 that would prohibit commercial substance from being predicated on tax cash flows that arise solely because the tax business purpose is based on achieving a specified financial reporting result. The staff believes that this co-dependence is a tax jurisdiction-specific issue that needs to be addressed by the respective tax authority. The fundamental question is whether the respective tax authority is going to grant the tax treatment - a question that a global financial reporting standard cannot answer. It should be noted that the staff does not necessarily believe that excluding from IAS 16 language similar to that which was agreed to by the FASB would result in a different accounting treatment for entities that operate in the US tax jurisdiction. The Board agreed that no change should be made in this regard. IAS 1 The Board concluded in ED 4 that non-current assets should not be reclassified as current under IAS 1 merely because they are held for sale. The staff proposed that the definition of current assets in the improved IAS 1 include the word 'normally expected', and 'Assets of a long-term nature are not reclassified as current assets when they are held for sale.' The Board disagreed with the staff proposal to change IAS 1 but, instead, concluded that the point be addressed specifically in the standard that results from ED 4. The staff recommended that paragraphs 54(d) and 60-63 of the exposure draft be amended to consistently apply the principle that the period for identifying assets or liabilities as current is the longer of twelve months after the balance sheet date and the entity's normal operating cycle. The Board agreed with the staff's recommendations. Some who commented on the Improvements exposure draft said that by removing the 'results of operating activities' from the mandatory line items in the income statement, information about most expenses will only be required to be presented within the profit or loss. It was suggested that, for symmetry with the line item 'revenue' in the income statement, a line item like 'expenses other than finance costs and tax expense' should be added. The Board did not agree with adding this line item.

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