The Board considered a paper prepared by the Australian Accounting Standards Board (AASB) staff on transitional arrangements for intangible assets under IFRS 1.

Current Australian GAAP permits entities to recognise an intangible item as an intangible asset when that item satisfies:

• the definition of an asset; and
• the general asset recognition criteria.

These criteria apply irrespective of the derivation of the intangible item. Therefore, Australian reporting entities are able to recognise intangible assets that cannot be recognised under IAS 38 and which would consequently be derecognised on adoption of IFRSs under IFRS 1.

The AASB staff believes that derecognition of certain internally generated intangible assets and past fair value revaluations on transition to IFRS would result in less useful information being provided to users of financial statements and ultimately compromise the relevance of financial statements.

This may lead to differences between comparable entities dependent on whether they can link the recognition or revaluation of these intangible assets to a specific event as allowed under IFRS 1.

The AASB therefore proposed that IFRS 1 be amended as follows:

"A first-time adopter may elect to recognise in its opening IFRS balance sheet an intangible asset that was recognised under its previous GAAP if that intangible asset meets:

(a) the definition of an intangible asset in IAS 38 Intangible Assets ;and

(b) the asset recognition criteria within the Framework for the Preparation and Presentation of Financial Statements.

The first-time adopter shall continue to recognise the intangible asset at its carrying amount immediately before the date of transition to IFRSs when the carrying amount:

(a) is based on:

i. cost and is broadly comparable to cost, or amortised cost under IFRSs; or

ii. revalued amount, and the revaluation is either an independently determined valuation that is broadly comparable to fair value at the date of the revaluation, or is supportable by a current independent valuation; and

(b) has been subject to impairment considerations since the date of initial measurement or the date of revaluation."

The Board clarified that to use the exemption in paragraph 19 of IFRS 1 the prior valuation had to constitute deemed cost at the time of the valuation and the transaction at the time of the valuation should be one that establishes the overall value of the entity similiar to a business combination.

The Board did not support (14-0) the proposed amendment to IFRS 1 but noted that there is a project on Intangible Assets that may change the accounting for these assets in the future.

It was noted that the IFRIC would be asked to clarify the interpretation of paragraph 19 of IFRS 1.

The Board considered an issue that arose during the drafting of the pre-ballot version of the IFRS on business combinations. The issue relates the Board's decision that the IFRS should not apply to the accounting for the following transactions until guidance on the application of the purchase method to those transactions has been issued by the Board. These transactions are:

• business combinations involving two or more mutual entities; and
• business combinations in which separate entities or businesses are brought together to form a reporting entity by contract only without the obtaining of an ownership interest (for example, combinations in which separate entities are brought together by contract only to form a dual-listed corporation).

The Board had previously decided that the current IAS 22 would apply to these transactions. The staff queried whether the Board believed these transactions could be accounted for as an uniting of interest or under a different application of purchase accounting permitted under "IFRS 3".

The staff proposed that the reference to these transactions being accounted for under IAS 22 be removed, the scope exemption under "IFRS 3"be retained, and the entity be consequently required to select appropriate accounting policies under the guidance in IAS 8.

The Board agreed with removing the reference to IAS 22 and withdrawing it completely. However, they agreed to scope these entities into "IFRS 3" except for goodwill (vote 13-1). The Board agreed that this should be exposed. It was noted that initially these entities would be scoped out of "IFRS 3", which could be amended subject to the results of the exposure draft, but IAS 22 would be withdrawn.

The staff suggested that the guidance in the proposed exposure draft was incomplete in that it addressed only those expenditures that could be included in the exploration and evaluation asset and did not address those expenditures that could not be included. The staff proposed including guidance based on equivalent paragraphs in IAS 16 that addresses initial and subsequent measurement. The staff believed that having specified the initial measurement, guidance on subsequent measurement should also be included.

The staff noted a concern that the requirement to recognise an asset initially at cost might be a change in practice - for example, an entity might include some estimate of the value of reserves in the initial carrying amount of the exploration and evaluation asset recognised. In addition the requirement to apply either IAS 16 or IAS 38 might cause changes to existing practices.

The Board noted the concerns but agreed with the staff's proposal.

The Board considered an initial analysis of the comment letters received. It was noted that commentators in general were supportive of the Board addressing the issue but many believed the Board had not gone far enough in the proposals.

Question 1: Designation and effectiveness

Question 1 in the ED was on the designation of the hedged item and the resulting measurement of ineffectiveness. The ED proposed that the hedged item be designated in terms of an amount of currency (rather than in terms of individual items) and be expressed as a percentage of assets or liabilities in a time period (rather than as a layer, or as the net position of assets and liabilities). As a result, ineffectiveness would arise both if a change in prepayment expectations caused the entity to be over-hedged (because hedged items were now expected to prepay earlier than expected) and if such a change caused it to be under-hedged (because hedged items were now expected to prepay earlier than expected).The ED also proposed that the change in the fair value of the hedged item may be reported in one of two line items in the balance sheet, and need not be allocated to the many individual assets or liabilities that comprise the hedged position.

The main points made in the responses were as follows:

• All who commented supported the proposal that the hedged item be designated in terms of an amount of currency (rather than in terms of individual items).
• Similarly, all who commented supported the proposal that that the change in the fair value of the hedged item may be reported in one of two line items in the balance sheet (rather than being allocated to the many individual assets or liabilities that comprise the hedged position).

The staff noted that a minority of those who commented on the issue supported the Board's proposal to designate the hedged item as a percentage of the assets of liabilities in a time period but many did not.

The main views expressed by those who disagreed included:

• The Board should not specify a method of designation. Rather entities should be allowed to choose whichever method best reflects their risk management strategies and objectives, or that minimises systems changes.
• The net position should be designated as the hedged item, at least for the purpose of testing effectiveness, since this reflects how interest rate risk is assessed and managed by the entity.
• A top layer of assets or liabilities (approach B/C in the ED) should be designated as the hedged item, since this most closely reflects the risk management objective. This objective is to take account of the extent to which liabilities form a natural offset to assets, and to hedge only (some or all of) the resulting net position with derivatives.

Many stated that no ineffectiveness should arise if a change in prepayment expectations caused the entity to be under-hedged (because hedged items are now expected to prepay earlier than expected). The main reasons given were:

• The entity is hedging only interest rate risk and not prepayment risk. Prepayment risk may be managed by deliberately hedging less than the full risk position, but it is not hedged. Accordingly, any changes in prepayment risk are changes in a risk that is not hedged and should not give rise to ineffectiveness, unless they cause the amount of the derivative to exceed the amount of the hedged position.
• The entity is hedging the assets (or liabilities) for a part of their life - the period up to the expected repayment date. Such partial term hedging is explicitly permitted by the implementation guidance to IAS 39. The entity is not hedging interest rate risk for the period after the expected repricing date. Accordingly, if prepayment expectations for this unhedged period change, there is no ineffectiveness.

Question 2: Core deposits

The ED proposed that a financial liability that the counterparty can redeem on demand cannot qualify for fair value hedge accounting for any time period beyond the shortest period in which the counterparty can demand payment.

A minority of respondents of those who commented on this proposal agreed with it. However, most did not. The main reasons given by those disagreeing were:

• The ED's proposal does not reflect the 'economic reality', supported by historical data, that core deposits are a stable source of long-term funding.
• It is inconsistent to schedule prepayable assets based on their expected prepayment dates, but not to schedule demand deposits based on their expected withdrawal dates.
• The ED's proposals could result in a bank being able to adopt fair value hedge accounting for some time periods (those for which it has more fixed rate assets than fixed rate liabilities) but not for others. This could result in the bank using a mix of fair value hedge accounting and cash flow hedge accounting for a single macro hedge, that would be both impractical to apply and difficult for users to understand.
• Portfolios are different from individual items. It is the economic behaviour of the portfolio that is being hedged and the hedge is successful as long as there are sufficient amounts, on a portfolio basis, to cover the hedging derivative. When viewed on a portfolio basis, core deposits behave as a liability with a repricing profile that is longer than that defined by the contractual terms. Furthermore, the details of individual transactions are lost at a portfolio level and the distinction between 'old' and 'new' money has no real meaning.
• The ED's proposals do not reflect the way that banks manage interest rate risk.

The staff noted that a few respondents urged the Board to continue to work on how to fair value core deposits and similar items in its measurement project. Some of these support the ED's proposals in the meantime, whilst others do not.

The Board members provided comment to assist the staff in preparing a more detailed analysis of the comments.

The staff noted a number of other issues raised and requested guidance from the Board on which issues should be addressed. The issues together with the staff's recommendations were:

Portfolio hedges of other risks

Some respondents suggest that the scope of the proposals be expanded to cover portfolio hedges of other risks, including foreign currency risk (this is the risk that was mentioned most often), commodity price risk, precious metal price risk, equity price risk, credit risk, energy price risk and the currency risk of portfolios of commercial bids.

The staff believes these reasons for limiting any amendment to only portfolio hedges of interest rate risk as set out in paragraph BC4 of the ED still hold, and proposes that the Board should not address these issues in finalising the ED's proposals.

Amortisation of balance sheet amounts

A significant number of comments were received on when or how to amortise any amounts reported in the balance sheet for changes in the fair value of the hedged item (ie the amounts that would be reported in the proposed separate line items). The ED was silent on this issue, though guidance is given in IAS 39.

The staff believes that the comments revealed considerable confusion over when amortisation is needed in order for an economically hedged position to be reported as such and recommends that this issue be addressed in finalising the ED' s proposals, perhaps by extending the application guidance or the illustrative example.

IAS 39's effectiveness requirements

IAS 39 requires that a hedge can qualify for hedge accounting only if it is expected to be highly effective (the 'prospective effectiveness test') and is determined actually to have been highly effective (the 'retrospective effectiveness test'). For the purposes of the prospective effectiveness test, the changes in the fair value or cash flows of the hedging instrument must be expected to "almost fully offset" those of the hedged item arising from the hedged risk. For the purposes of the retrospective effectiveness test, a 80-125 per cent range is applied. Some respondents request clarification of how these requirements apply to a macro hedge.

The staff recommends that this issue be considered by the Board in finalising the ED so that it is clear what the effectiveness requirements are for a macro hedge, and whether macro hedges will meet them.

Transitional provisions

The ED proposed that it be applied prospectively. Comments raised on this proposal ask that it be clarified whether 'prospectively' means the amendments can be applied to accounting periods after the effective date, or only to new transactions occurring after that date, and that the Board address how an entity that already reports under IAS 39 and that uses cash flow hedge accounting for its macro hedges should transition to using fair value hedge accounting.

The staff recommends that the Board should address these issues in finalising the ED's proposals.

Other points

A large number of smaller points were raised.

The staff recommends that these smaller points be considered in the first instance by the Board members assigned to the project, and that their proposed resolution be presented to the full Board for approval on an exceptions-only basis.

The Board agreed with the staff's recommendations.

The staff noted that the project plan proposed discussing designation and effectiveness and core deposits in January and all other issues in February.

The Board noted a summary of recent IFRIC activities.

Rights of Use of Assets

It was noted that an exposure draft on Rights of Use had been approved by the Board and once an editorial review had been completed would be issued.

Emission Rights

In addition the Board considered a request from the IFRIC to make a limited amendment to IAS 38 arising from the IFRIC's redeliberation of its proposals for accounting for emission rights.

The IFRIC proposals dealt with schemes where a participant is set a target to reduce its emissions to a specified level (the cap) in a compliance period. At the start of the compliance period, the government allocates the participant allowances equal to its cap, normally free of charge. Participants can trade their allowances with other participants or brokers. At the end of the compliance period (normally a year) the participant must deliver to government an allowance for each tonne of pollutant emitted in the year. If it fails to do so, it incurs a penalty.

The IFRIC proposed a model that accounts for the allowances independently to the obligations arising under the scheme. Accordingly:

• allowances, whether allocated by government or purchased in the market, are intangible assets and are accounted for in accordance with IAS 38. Allowances that are allocated for less than fair value are measured on initial recognition at fair value. Allowances are not amortised but are tested for impairment.
• when allowances are allocated by government for less than fair value, the difference between their fair value and the amount paid is a government grant that is accounted for in accordance with IAS 20.
• as emissions are made, a provision is recognised for the obligation to deliver allowances to cover those emissions (or to pay a penalty). The provision is accounted for under IAS 37 and therefore is normally measured at the market value of the required number of allowances.

Most respondents to the draft Interpretation were concerned about the lack of symmetry (or mismatch) in the accounting and the resulting volatility of reported profit or loss. This arises because:

• Under the benchmark treatment in IAS 38, the asset for allowances held is measured at cost. If the participant uses the allowed alternative treatment, the asset is measured at fair value but changes in value above cost are recognised in equity.
• The liability for the obligation to deliver allowances to cover emissions to date is measured under IAS 37 by reference to the market value of the allowances needed to settle it, and changes are recognised in profit or loss.
• The government grant is initially recorded as a deferred credit at cost and subsequently that cost is amortised to profit or loss.

The IFRIC reviewed alternative models suggested by respondents to the draft Interpretation, but concluded that its proposals are the most appropriate interpretation of current IFRSs. Nonetheless, the IFRIC acknowledged that the constraints of existing Standards lead to a mismatch in measuring and reporting the changes in the values of the assets and liabilities that arise in an emission rights scheme.

The IFRIC considered the characteristics of an emission allowance that distinguish it from most other intangible assets referred to in IAS 38. The IFRIC concluded that its unique feature is that it is akin to a currency. This is because the value of an allowance derives from the fact that it is used to settle an obligation (ie the obligation to deliver allowance as a result of past emissions).

The IFRIC agreed that the most representationally faithful way to report any intangible asset that, like an allowance, is akin to currency and which is traded in an active market, is at fair value with changes in value recognised in profit or loss.

The staff and the IFRIC recommended that the Board amend IAS 38 so that an intangible asset (a) that is like a currency, in that it has value only because it is used to settle an obligation; and (b) whose fair value is determinable by reference to an active market (as defined in IAS 38) is measured at fair value with changes in value recognised in profit or loss.

The Board discussed this issue and the treatment of the deferred credit arising under IAS 20. Some Board members queried why this should be restricted only to these types of intangible assets and should not include all intangible assets. The Board agreed to consider papers proposing to withdraw IAS 20 and consider the related revenue recognition issues. In addition the Board agreed that IFRIC could proceed with a proposal to require the subset of intangible assets to be revalued through profit and loss but this would only be issued at the same time as the IAS 20 proposal.

The Board considered various issues arising from preliminary drafts of the final standard.

The staff proposed including a definition of "employees and others providing similar services". The staff recommended that employees be defined broadly, so that it includes not only individuals who are employees for legal or tax purposes, but also individuals who work for the entity under its direction in the same manner as individuals who are regarded as employees for legal or tax purposes.

The Board agreed with the staff proposals together with a clarification that all directors, including non-executive directors, are included in this category. It was noted that this could be done by including a reference to "key management personnel" as defined in IAS 24. It was also agreed to include examples of various inclusions and exclusions.

The staff proposed including a definition of the phrase 'market condition'. In addition the staff has also proposed including two illustrative examples in the implementation guidance to illustrate the application of the requirements of the IFRS to a grant of equity instruments with a market condition and to clarify what happens in situations in which a grant includes both a market condition and a non-market performance condition.

The Board agreed with the staff proposals.

The staff noted that in certain cases the Board had agreed that the entity should measure the equity instruments at their intrinsic value, and remeasure intrinsic value until exercise date.

The staff recommends that the IFRS specify that the requirements for market conditions, modifications and cancellations do not apply under the exercise date/intrinsic value method. The staff also recommended that if an entity settles a grant of equity instruments to which the exercise date/intrinsic value method has been applied:

(a) if the settlement occurs during the vesting period, the entity should account for the settlement as an acceleration of vesting, and hence should recognise immediately the amount that would otherwise have been recognised for services received over the remainder of the vesting period.

(b) any payment made on settlement should be accounted for as the repurchase of equity instruments, ie as a deduction from equity, except to the extent that the payment exceeds the intrinsic value of the equity instruments, measured at the repurchase date. Any such excess should be recognised as an expense.

The Board agreed with the staff proposals.

The Board had previously agreed that the IFRS should include a requirement to disclose information about the number or percentage of equity instruments expected to vest, as estimated at the beginning and end of the period, along with a brief explanation of the reasons for any significant change in estimate during the period. The staff recommended that this disclosure requirement be deleted.

The Board agreed with the staff proposal.

The staff recommended including a requirement in the transitional provisions that the entity should apply with the paragraphs of the IFRS that require disclosure of information on the nature and extent of share-based payment arrangements that existed during the period.

The Board agreed with the staff proposal.

Some questions have arisen as to whether there should be some disclosures concerning liabilities arising from share-based payment transactions.

The staff recommended that, if the Board wishes to include some disclosure requirements concerning liabilities, this should be limited to the opening and closing balance of any such liabilities, and details of movements during the period.

The Board agreed that the closing balance and the intrinsic value at balance sheet date should be disclosed.

The staff recommended adding some guidance to clarify that, if the goods or services are received on more than one date, the entity should measure the fair value of the equity instruments granted on each date when goods or services are received, and apply that fair value when measuring the goods or services received on that date. However, an approximation could be used in some cases. For example, if an entity received services continuously during a three-month period, and its share price did not change significantly during that period, the entity could use the average share price during the three-month period when estimating the fair value of the equity instruments granted.

The Board agreed with the staff proposal.

The Board noted the FASB decisions in respect of the tax effects of equity-settled transactions. These being:

• If the tax deduction arises in a later period than when the expense is recognised, a deferred tax asset should be recognised, based on the cumulative expense. The current share price should not be taken into account, for recognition or impairment purposes.
• If the tax deduction ultimately received is less than the cumulative expense, the writeoff of the unrecovered portion of the deferred tax asset should be recognised in the income statement.
• If the tax deduction ultimately received is greater than the cumulative expense, the excess tax benefits received should be recognised directly in equity.

The staff noted that although the two Boards have agreed to substantially the same allocation method, and hence the ultimate outcome should be the same under either approach in most cases, there will be differences in the interim accounting, because of differences in the measurement of the deferred tax asset, as follows:

• Under the IASB method, the deferred tax asset is recognised based on an estimate of the future tax deduction. If changes in the share price affect that future tax deduction, the deferred tax asset will be remeasured in each period. In contrast, the FASB method takes no account of the current share price. This means that the amount of the deferred tax asset under the FASB method is likely to differ from the amount under the IASB method.
• Because the IASB method recognises a deferred tax asset based on the expected future tax deduction, and this includes both the expected tax benefits allocated to the income statement and the expected tax benefits allocated to equity, there may be tax benefits recognised in equity at an earlier date than under the FASB method.

A further difference is that under the IASB method, the allocation between the income statement and equity applies irrespective of why the tax deduction differs from the cumulative expense. Under the FASB method, the allocation of tax benefits between the income statement and equity applies only if the tax deduction differs from the cumulative expense because of the application of a later measurement date for tax purposes. In other situations, in which a difference arises for reasons that have nothing to do with an equity transaction or event, all of the tax benefits received would be recognised in the income statement.

The Board noted the four views of revenue previously discussed, these being:

• The Gross Inflows View
• The Liability Extinguishment View
• The Broad Performance View
• The Value Added View

The staff noted that the Board previously agreed that the definition of revenues should not be based on the Gross Inflows View as defined or the Value Added View. The Board had also agreed that the working definition of revenues should focus on activities related to the provision of goods and services to customers.

In addition the staff noted that the Board had approved a preliminary set of working criteria for revenue recognition, termed the elements criterion and the measurement criterion, that focus on uncertainties about whether the elements definitions have been met (element uncertainty) and uncertainties about the ability to reliably measure the item in question (measurement uncertainty). Revenues should be recognised when both of those criteria are met.

The elements criterion

The elements criterion requires that a change in assets or liabilities has occurred, specifically:

1. An increase in assets has occurred that increases equity, without a commensurate investment by owners; and

2. A decrease in liabilities has occurred that increases equity, without a commensurate investment by owners (such as the forgiveness by owners of a debt owed to them by the entity).

The measurement criterion

The measurement criterion requires that the change in assets or liabilities can be appropriately measured, specifically:

1. The assets or liabilities are measured by means of a relevant attribute; and

2. The increase in assets or decrease in liabilities is measurable with sufficient reliability.

Contractual rights

It was further noted that the Board had considered the economic consequences that contractual rights have for their holders and that related contractual obligations have for their obligors, and tentatively decided that:

• Conditional rights and obligations do not meet the definitions of assets and liabilities.
• Unconditional rights and mature rights meet the definition of an asset if they are enforceable and give access to future economic benefits.
• Unconditional obligations and mature obligations meet the definition of a liability if they are enforceable and oblige the entity to make a future sacrifice of economic benefits.
• Unless a contract is enforceable, the obligations that it imposes on the contracting parties will not meet the definition of liabilities, and the corresponding rights that it conveys to counterparties will not meet the definition of assets.
• Contractual rights and obligations that qualify for recognition as assets and liabilities should initially be measured at their fair values.

The staff further noted for enforceable contracts the Board discussed whether the unit of account (the subject of recognition) should be the individual assets and liabilities arising from the rights and obligations embodied in the contract or the contract as a whole and had agreed that:

The unit of account should be based on the legal remedies for a breach of contract that are available to the contracting parties.

• For contracts for which the only legal remedy for a breach of contract is money damages, the only outcome that could occur from settling the contract before performance of the items specified in the contract (that is, while the contract remains executory) is a flow of cash in one direction between the contracting parties. As a result:
• One party has a pre-performance asset and the other a pre-performance liability (pre-performance assets and liabilities are the unconditional rights and obligations that exist until either party to a contract performs its stated conditional obligation); and
• The unit of account should be the contract as a whole and a net amount should be recognised.

For contracts having the legal remedy of specific performance for a breach of contract (which is available to an entity if it would not be compensated adequately by an award of money damages):

• That legal remedy renders unconditional the rights to performance of the items specified in the contract and the related performance obligations for the contracting parties.
• The only outcome that could occur from settling the contract at any time (unless one of the parties forgoes its right to specific performance) is flows of assets in both directions between the contracting parties. As a result:
• Each contracting party would have at least one asset and one liability; and
• The unit of account for each party should be the individual assets and liabilities arising from its contractual rights and obligations, reported on a gross basis.

The staff noted that the Board tentatively agreed to use fair value as the measurement attribute for analysing issues, but not to decide the measurement attribute for an exposure draft until decisions are made in the Measurement project. The staff further noted that the Board has discussed whether the fair value of performance obligations should reflect the price that the reporting entity would have to pay a third party to assume responsibility for performing all of those obligations (generally "wholesale" fair value) rather than the amounts at which the reporting entity sold (or could sell) identical or similar products or services to similarly situated customers (generally "retail" fair value).

It was clarified that no decision had been taken on whether a remeasurement of a performance obligation should occur but the working principle to use fair value would imply that if remeasurement were to take place it would be at fair value. In addition certain Board members requested clarity in determining the markets to be used in both the "wholesale" and "retail" methods.

The Board discussed a definition of a small and medium-sized entity. The staff proposed the following definition:

The International Accounting Standards Board does not determine which entities should apply International Financial Reporting Standards (IFRS) or which entities should apply International Financial Reporting Standards for Small Entities (IFRSSE). Those are matters to be decided by national governments, securities regulators, stock exchanges, and accountancy bodies.

The IASB has developed the IFRSSE with the intention that they are suitable for entities that do not have public accountability. The IFRSSE would not be suitable for entities that have public accountability; IFRSs are intended for them. An entity has public accountability if it meets any one of the following criteria:

• 1. It has issued equity or debt securities that trade in a public securities market.
• 2. It is in the process of issuing equity or debt securities in a public securities market.
• 3. It is a financial institution that holds funds in trust for a broad group of outsiders, such as a bank, insurance company, securities brokerage, pension fund, mutual fund, or investment banking entity.
• 4. It is intensely rate regulated by the government for public policy reasons,such as a public utility company.
• 5. It is of national economic significance in the country in which it is domiciled.
• 6. It is majority owned by a government or government agency.
• 7. It is a subsidiary of an entity that meets one of the above criteria.

The Board agreed to incorporate a paragraph that would state that entities may only claim compliance with the standard if they comply with all its requirements and they do not have public accountability. In addition the Board agreed that entities within the scope of this standard could prepare financial statements in compliance with full IFRS.

The Board agreed to include a paragraph describing what is meant by public accountability based on the principles in the Canadian standard. The indicators should be reworded as examples based on the principle. The Board agreed to delete indicators 6 and 7. Indicators 1 to 5 would be retained, with some wording changes.

The Board agreed, in addition, that only entities whose shareholders agree unanimously would be eligible to apply the standard.

The Board considered comments arising from the exposure draft. The staff noted that some commentators believed the project was not essential to 2005 and need not be completed by March 2004. The Board disagreed and agreed to proceed with the project. The Board reiterated that this was part of the convergence project and that comments should be considered mindful of the objectives of the convergence project. The Board discussed the comment that the focus of the project should be assets retired from active use but agreed to retain the current focus. The Board also agreed to not deal with provisioning consequences of abandoned assets as part of this project but that the topic should be dealt with as part of considerations of IAS 37.

Classification of assets held for sale

The staff recommended that the criterion that the sale should be expected to be completed within a year should be removed, and therefore also the exceptions to that criterion, on the grounds that such a criterion is not needed under (and indeed in some cases might be inconsistent with) the principle that the sale must be highly probable. The staff proposed the following wording in paragraphs 4 and 5:

4. An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. For this to be the case, the asset (or disposal group) must be available for sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups) and its sale must be highly probable.

5. Indications that a sale is not highly probable include:

(a) no commitment from management to a plan to sell

(b) no active programme to locate a buyer and other actions required to complete the plan to sell the asset (or disposal group)has been initiated

(c) the asset (or disposal group)is not being actively marketed for sale at a price that is reasonable in relation to its current fair value

(d) actions required to complete the plan indicate that it is likely that significant changes to the plan will be made or that the plan will be withdrawn."

The Board expressed concern that this would allow entities to classify any asset to be included in this category and believed the reference to 12 months should be reinstated. They believed that there could be exceptions to this such as regulatory approval and examples of such exceptions should be included. The Board believed this could be expressed as a principle with guidance as to how it should be applied.

Measurement of Assets

The staff noted that many commentators did not agree with the measurement proposals in ED 4. The staff believed that these commentators did not understand that the results of these proposals were similar to what would result from applying the revised IAS 16 and 36.

The staff recommended that the proposals in ED 4 in this area be retained. The Board agreed.

Disposal Groups

The staff recommended that the following amendments be made in this area:

(a) the relationship between disposal groups and cash-generating units should be clarified,

(b) the interaction between the scope of ED 4 and the application of the requirements to disposal groups should be clarified,

(c) impairment of any goodwill allocated to a disposal group should not be calculated separately but that the allocation of the impairment loss of the disposal group as a whole should be allocated first to goodwill, consistent with IAS 36,and

(d) the allocation of any remaining impairment loss should be allocated pro-rata to all the assets in the disposal group, consistent with IAS 36.

The Board agreed with a, b and d above but believed c was not necessary.

Commercial Substance

The staff proposed that the standard include wording that states it does not apply to exchanges of assets without commercial substance as detailed in the revised IAS 16. The Board agreed but stated that this should be cross-referenced to IAS 16.

Newly Acquired Assets

The staff recommended adding the following words in this area:

If a newly acquired asset (or disposal group) meets the criteria to be classified as held for sale (see paragraph B3 of Appendix B), it shall be measured on initial recognition at the lower of cost and fair value less costs to sell, unless the asset (or disposal group) acquired is part of a business combination, in which case it shall be measured on initial recognition at fair value less costs to sell.

The Board agreed.

The Board considered both issues that should be addressed in a longer-term project and a short-term proposal to permit immediate recognition of actuarial gains and losses in a different manner to that permitted by IAS 19. The staff recommended:

• a. that a long-term comprehensive project on post-employment benefits should be considered as a candidate for a joint project between the IASB and FASB by the joint agenda working party.
• b. that the Board should also proceed with a short-term project on post-employment benefits with a view to issuing an exposure draft around June 2004.
• c. that the exposure draft should propose that an option should be added to IAS 19 whereby, if actuarial gains and losses are recognised in full in the period in which they occur, they can be recognised outside income in a statement of changes in equity that includes only the items listed in paragraph 92 of IAS 1. Entities choosing this option would have to apply it to all actuarial gains and losses as currently defined under IAS 19.
• d. that the exposure draft should also propose:
  • (1) an exemption from defined benefit accounting for individual companies in a consolidated group
  • (2) the disclosure of the major classes of assets held by the plan and their expected rate of return and
  • (3) the disclosure of trend information.
  No other amendments relating to other issues considered in the project should be included in the exposure draft.
• e. that if the Board does not agree with the proposal for immediate recognition of actuarial gains and losses, then the following amendments to IAS 19 should still be proposed in the short-term:
  • (1) an exemption from defined benefit accounting for individual companies in a consolidated group
  • (2) the disclosure of the major classes of assets held by the plan and their expected rate of return.

The Board agreed with adopting both the longer-term and short-term projects under a and b above.

The Board agreed (13-1) to expose the option mentioned in c above provided the Basis for Conclusions states that the Board believes this is a temporary position, it improves financial reporting in this area as the balance sheet would reflect a more accurate position, and the actuarial gains and losses in the longer-term should not be in equity. It was agreed that the statement referred to should be given the name specified in the appendix to the revised IAS 1.

The Board agreed with the proposals in d(1) (vote 9-5), (b), and (c) above. It was agreed that the staff would also examine the recent FASB pronouncement on employee benefit disclosure to determine whether convergence could be achieved.

The staff noted that the Board had previously agreed that when an entity (the 'Investor'):

• (a) has the power to determine the strategic operating and financing policies of another entity ('Power Criterion ');
• (b) has the ability to benefit ('Benefit Criterion'); and
• (c) is able to use that power so as to increase, protect or limit the risk of downside in that benefit

the Investor has control of that other entity and should consolidate it.

The Board discussed how this definition would apply to an entity (called an SPE for discussion purposes) where the policies and significant decisions are predetermined and the predetermination is effectively permanent and immutable or unchangeable.

The staff proposed that the entity that predetermines the policies and significant decisions would meet the Power Criterion in the definition.

The Board agreed but noted that this may only be applied to a small set of circumstances and will need to be developed further.

The staff further proposed that an entity that subsequently accepts the predetermined issues will also meet the Power Criterion.

The Board agreed.

The staff noted that circumstances may exist where it is difficult to determine the application of the Power Criterion. The staff asked the Board to consider that in these circumstances control could be determined based on who is exposed to the residual risks of the SPE's assets.

The Board noted that this could be considered in determining who controlled the particular individual asset but highlights the difference in control over entities and individual assets.

The Board noted that an identification of risks and rewards within the SPE approach may have merit and should be explored further.

Assets backing insurance liabilities

The staff noted that the Board had requested the staff to research why insurers cannot classify a higher proportion of their fixed-maturity investments as held-to-maturity. The staff reported that there appeared to be two main reasons:

• If the asset liability management (ALM) involves duration matching, the portfolio needs to be rebalanced periodically to remain within the ALM targets. This would involve, for example, selling bonds that have deteriorated beyond the level the insurer has undertaken or is required to maintain.
• For a life insurer, lapses could change at any duration. Thus, the insurer needs to keep an adequate buffer as available for sale at each duration. For example, for a twenty-year liability, a 2.5%buffer for each year would add up to 50%.

In addition the staff noted the Board had requested research into three potential approaches, these being:

• (a) Relax the criteria for classifying a fixed-maturity asset as held-to-maturity and the related 'tainting provisions' in IAS 39. The tainting provisions are a way of ensuring that an entity classifies a financial asset as held-to-maturity only if the entity has a positive intent and ability to hold the asset to maturity.
• (b) Create a new category of fixed-maturity assets that could be reported at amortised cost - Assets Held to Back Insurance Liabilities.
• (c) Adjust the measurement of interest-sensitive insurance liabilities to reflect changes in interest rates that also have a corresponding effect on the fair value of fixed-maturity financial assets that are designated as backing those liabilities (and are carried at fair value and meet various restrictions to be determined).

The staff recommended the Board reject approach a and b above and continue discussions with insurers to assess whether approach c can be made workable.

It was noted that certain Board members believed there was no evidence insurers were matching insurance liabilities with assets at the level discussed and consequently no mismatch problem existed for which a solution was necessary.

The Board indicated a preference for a liability-based solution rather than an asset based solution (10-4).

The staff noted they would be meeting with representatives of certain insurance entities to pursue any potential solution taking the Board's guidelines into account.

Shadow accounting

The staff noted that the rationale for shadow accounting is that a recognised but unrealised gain or loss on an investment asset should have the same effect on the measurement of insurance assets (deferred acquisition costs) and liabilities that would have occurred had the gain or loss been realised. Stated differently, it is designed to record the knock-on balance-sheet effects of recognising unrealised gain or loss.

The staff recommended that the Board confirm explicitly that an insurer may (but is not required to) change its accounting policies so that a recognised but unrealised gain or loss on an asset affects the measurement of related insurance liabilities (and deferred acquisition costs) in the same way that a realised gain or loss does. If the unrealised gains or losses are recognised directly in equity, the related adjustment to the insurance liability or deferred acquisition costs should also be recognised in equity.

The staff further recommended that the Basis for Conclusions clarifies that shadow accounting is not the same thing as fair value hedge accounting and will not usually have the same effect.

The Board agreed with the staff's recommendations.

Temporary exemption from the hierarchy

The staff noted that the Board had previously requested clarification as to why ED 5 and the draft Exposure Draft on Exploration for and Evaluation of Mineral Resources take different approaches to the hierarchy.

The Board did not discuss this in detail but agreed with the staff recommendation that the Board should:

• Maintain the temporary exemption from paragraphs 5 and 6 of IAS 8.
• Delete the 'sunset clause', so that the exemption would not expire in 2007.

Changes in accounting policies

The staff noted that the exposure draft proposed that accounting policies for insurance contracts may be changed subject to certain conditions and subject to certain limitations on unacceptable policies.

The staff recommended that the absolute prohibition on introducing measurements that reflect future investment margins be replaced with a rebuttable presumption. The staff noted that the main purpose of this is to avoid blocking a switch to comprehensive methods of accounting for insurance contracts that involve asset-based discount rates.

The staff further recommended that changes in accounting policy for insurance contracts should be permitted if they make the financial statements more relevant and reliable, as proposed in ED 5.

The staff noted that it would follow from these recommendations that insurers would be able to introduce embedded value measurements, but only if:

• They show that this results in more relevant and reliable information. This is not an automatic decision and will depend on a comparison of the insurer 's existing accounting with the way in which it intends to apply embedded value.
• This increase in relevance and reliability is sufficient to outweigh the rebuttable presumption against including future investment margins.
• The embedded value includes contractual rights to future investment management fees at an amount that does not exceed their fair value as implied by a comparison with current fees charged by other market participants for similar services.

The Board agreed with the staff's recommendations.

Discounting

The staff recommended that there should be no change to the proposal in ED 5 that discounting should not be required in phase I, but an insurer should continue discounting of insurance liabilities that it already discounts.

The Board agreed.

Excessive prudence

The staff recommended that phase I should not try to define or eliminate excessive prudence.

The Board agreed.

Redesignation of financial assets

The staff recommended retaining the approach in ED 5, in particular to not restrict the redesignation to assets backing the insurance contracts for which the accounting policies were changed.

Certain Board members noted that this could be affected by any potential solution to the mismatch problem. Other than in this area, which was left pending, the Board agreed with the staff's recommendations.

Scope

The staff proposed clarifying in the implementation guidance and scope that:

• Premiums paid by an employer on behalf of the employee where the employer issues the contract are employee benefits.
• Policy holders of insurance contracts are not included.

The Board agreed.

The staff noted that commentators queried whether entities that provide services and/or parts whenever a breakdown occurs falls within the insurance contract scope. The Board believed they did but because Phase 1 does not require current practice to be changed this would be addressed in Phase 2.

Weather derivatives

The staff recommended no substantive changes in this area. The Board agreed.

Definition of an insurance contract

The staff recommended retaining the definition. The Board agreed.

Insurable interest

The staff recommended no changes in this area. The Board agreed.

Pure endowment

The staff recommended that there be no change in principle in this area but that it be reworded. The Board agreed.

Significance of insurance risk

The staff recommended that there be no change in principle in this area but that it be reworded to refer only to significant, insignificant and commercial substance. In addition the staff proposed adding further clarification in the areas of the basis for the significance test and surrender charges.

The Board agreed.

Embedded derivatives

The staff recommended the following changes:

• (a) Changes to IG Examples 2.4, 2.6(a) and 2.11, which identify embedded derivatives that are interdependent with the host insurance contract; this interdependence suggests that they are closely related to the host contract.
• (b) An explicit new exemption from the requirement to separate, and measure at fair value, options to surrender a contract with a discretionary participation feature.
• (c) Permit unit-denominated payments to be measured at current unit values, for both insurance contracts and investment contracts, thus avoiding the apparent need to separate an 'embedded derivative'.

Concern was expressed as to the changes in a above. The staff were requested to consider this further.

Further concern was expressed that the loss recognition test does not require an entity to consider cash flows from all guarantees and options. The staff were requested to consider this further.

The Board agreed with recommendations b and c above.

Unbundling of deposit components

The staff recommended that:

• Unbundling should be permitted if the deposit component (including any embedded surrender options) can be measured without considering the insurance component.
• Unbundling should be required if some rights and obligations under the deposit component would otherwise remain unrecognised.

To implement these recommendations, the staff recommended that paragraphs 7 and 8 be reworded as follows:

7. Some insurance contracts contain both an insurance component and a deposit component (a component that would, if it were a separate instrument, be within the scope of IAS 39). An insurer may unbundle those components (ie account for those components separately) if it can measure the deposit component (including any embedded surrender options) independently without considering the insurance component. Furthermore, if the insurer can measure the deposit component independently, unbundling is required if the insurer 's accounting policies do not otherwise require it to recognise obligations or rights arising under the deposit component. If all obligations or rights under the deposit component are recognised, unbundling is not required, regardless of the basis used to measure those rights and obligations.

7A. The following is an example of a case when an insurer 's accounting policies do not require it to recognise all obligations under a deposit component. An insurer receives a payment from a reinsurer to compensate it for losses, but the terms of the contract mean that the insurer is compelled to make additional payments in future years as a direct result of the receipt from the reinsurer. The obligation to make those additional payments arises under a deposit component. If the insurer 's accounting policies do not capture that obligation, unbundling is required.

7B To unbundle a contract, an insurer shall:

(a) treat the insurance component as an insurance contract.

(b) treat the deposit component as a financial liability or financial asset under IAS 39.

8. Many traditional contracts provide surrender or maturity benefits that could be regarded as deposit components. Nevertheless, paragraph 7 does not require an insurer to unbundle those benefits if the insurer recognises its obligations to pay those benefits.

The Board agreed.