Amendments to IAS 37 Non-financial Liabilities

Date recorded:

Does the proposed measurement principle permit a choice?

The staff reminded the meeting that the measurement principle proposed in the IAS 37 ED was that 'An entity shall measure a liability at the amount that it would rationally pay to settle the present obligation or transfer it to a third party on the balance sheet date'. This principle was derived from the current explanation of 'best estimate' in IAS 37 paragraph 37. The staff proposed removing the notion of 'amount to transfer' from the measurement principle in any final standard. Board members noted that 'settlement' was a broader notion than transfer and opened the door to ambiguity-something acknowledged by the authors of IAS 37 and its UK equivalent. Others expressed concern that 'settle' was being used to imply 'extinguishment' or legal defeasance (that is, the derecognition notion in IAS 39); this was not the measurement objective of IAS 37 as exposed.

Still other Board members noted that in languages other than English, 'settlement' subsumed 'transfer' but 'transfer' excluded 'settlement'.

It was evident that the Board was split on the staff proposal, and for very significant reasons. To use 'transfer' would suggest that the measurement attribute was 'exit fair value'. Senior staff warned the Board that to use terms and notions from FAS 157 Fair Value Measurements was completely inappropriate: that document had not been through the IASB's due process and should not be assumed to be part of the IASB's canon of guidance.

Board members suggested that the Board should clarify what the measurement objective in IAS 37 was and what the components of that measure should be. Other Board members saw this as an inappropriate extension of the scope of the project. These Board members noted that constituents (and Board members) could identify two or three possible measures in IAS 37:

  • The amount that the entity could rationally agree [settle] with a third party to assume the obligation (the entity retains the credit risk);
  • The amount that the counter-party will accept from the entity to settle [extinguish] the obligation;
  • The sum of the cash payments that the entity expects to make to settle [extinguish] the obligation, discounted to the balance sheet date.

Board members discussed these notions for a while. It was noted that, given the limited scope of the project, the Board might have to accept that there were different approaches to measurement in IAS 37 and that the IASB should not pre-judge its fair value measurement project. Consequently, the IASB should explain that 'settlement' can occur either with the counter-party or with a third party. It was also noted that the discount rate used must include a risk premium appropriate to the obligation. As IAS 37 measures liabilities, the risk premium reduces the discount rate and increases the liability on the balance sheet. (A Board member noted that as a result of the implementation of IFRIC 1, it became apparent that preparers had been using the wrong discount rate - somewhere between the risk-free rate and the entity's investment hurdle rate.)

The Board also noted that 'rationally' was not a synonym for 'economically rational' - that is, it was possible that an entity might make a current estimate of the amount to settle the obligation as 100, but to transfer that obligation to a third party would cost 120. This was because, depending on the nature of the liability, the third party might demand a higher risk premium than the entity would incur. Alternatively, the higher premium might be the amount the entity would be prepared to pay to transfer the liability at the balance sheet date.

Board members seemed to accept that, for many obligations, measurement would have to include entity-specific inputs. Some Board members were very uncomfortable with this, but seemed to accept that imposing the alternative markets requirements in FAS 157 was impractical (and would trigger re-exposure).

The Board did not reach a conclusion on the staff's proposals and asked the staff to consider further the matters raised in the debate.

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