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Liabilities and Equity

Date recorded:

General remarks

The EFRAG representatives highlighted that some issues have to be addressed before comparing any approaches to distinguish between liabilities and equity (for example, who are the users, what is the perspective - reporting entity vs. issuing entity, etc.) and others, although important, do not (measurement, disclosure and income statement classification). It was also noted that there is a high number of cross-cutting issues like the Framework project. The representatives made clear that the characteristics of liabilities and equity are multi-dimensional, which made the dichotomous distinction difficult. Any selection of criteria was considered somewhat arbitrary.

Some Board members expressed their concern that some instruments, particularly puttable instruments with a fixed repayment amount, are considered loss absorbing under the loss absorption approach as developed in the EFRAG Discussion Paper. It was noted that some might interpret loss absorption capability as far reaching, that is even trade payables could be deemed loss absorbing in some scenarios. The Board and the EFRAG representatives had a lengthy debate on this issue.

Principle of loss absorption

The EFRAG representatives then continued to explain the principle of loss absorption. It was noted that one of the key features of equity instruments was considered to be the loss buffer function, in this case loss as defined by the accounting framework. It was also noted that the loss absorption approach would provide for reclassification when the terms change or certain triggers are met and split accounting for instrument not fully loss absorbing.

The Board discussed certain aspects of the loss absorption approach in depth. One Board member made a general remark that it would have helped the Discussion Paper of EFRAG if it had also covered measurement and disclosure issues.

Another Board member again expressed concern with loss absorbing capabilities being the distinguishing criterion, as at least on (involuntary) liquidation all instruments on the equity/liability section of the balance sheet would participate in losses - whether this was part of the contractual agreement or not. This Board member also noted that the EFRAG presentation explained that loss absorption clauses must be 'operational', but it was not clear what it means, and that he considered the existence of an obligation more fundamental for the distinction.

Some Board members asked how the loss absorption approach would avoid structuring opportunities. In response to that, another Board member explained that there will always be structuring, but that the incentive to do so could be mitigated by requiring certain measurement attributes and/or disclosures. It was also mentioned that a major issue were hybrid instruments and what would be the answer provided by the loss absorption approach.

Application within a group context

The EFRAG representative very briefly presented what the view to be taken was when the classification is made - an entity view or a proprietary view? The Board shortly discussed this issue in the light of both the EFRAG and the FASB's preferred approach.

The Board then returned to the discussion of what were the defining features of equity and what features would be covered under both the loss absorption and the basic ownership approach.

The Chairman wrapped up the session and asked the EFRAG representatives to develop a comparison between the loss absorption approach and the basic ownership approach in the light of the features highlighted in the EFRAG presentation and bring it back at a later point.

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