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Financial Instruments with Characteristics of Equity

Date recorded:

The staff noted that this session aimed to prepare Board members for and to facilitate the discussion to be held at the joint meeting of the Board and the FASB on 20-21 October 2008. No decisions were requested.

The staff noted that in order to complete the project by 2011, as contemplated by the project plan discussed by the IASB and the FASB in June, a decision was required at the joint IASB/FASB meeting regarding which approach the boards want to pursue. The staff explained that of the approaches outlined in the IASB's Discussion Paper Financial Instruments with the Characteristics of Equity, as well as others suggested by constituents (including the PAAinE 'loss absorption approach'), the staff preferred what had been labelled the 'Perpetual approach'. The Perpetual approach would classify an instrument as equity if it (a) lacks a settlement requirement and (b) entitles the holder to a share of the entity's net assets in liquidation. The staff explained that this approach was similar to the classification approach in IAS 32 except that derivatives over an entity's own equity would not be classified by the issuer as equity. The FASB had discussed the paper presented in a public education session and none of the FASB members had expressed opposition to the approach at that meeting.

One Board member expressed concern that the loss absorption approach seemed to be dismissed somewhat summarily in the staff paper. However, another Board member noted that the Board had held two sessions dedicated to the model and most Board members remained unconvinced that something that looks like commercial paper should be classified as equity.

Most Board members expressed support for the staff recommendation. A common thread in the discussion was that the perpetual approach was superior to the basic ownership approach advocated in the Discussion Paper, although inconsistencies between IAS 32 and the IASB Framework and FAS 150 and the FASB's Concept Statements were acknowledged.

Some Board members noted that they would not support any approach that permitted an entity to write a put on its own equity and treat that equity as treasury or repurchased shares. In their view, the equity was still in issue and the entity had written a derivative which should be subject to normal derivative accounting.

Some Board members retained a preference for the basic ownership approach, because it provides a cleaner answer when compared with that in the perpetual approach for such instruments as puttable shares and instruments subject to 'economic compulsion'. Some Board members acknowledged these difficulties and suggested that the superior answer to the puttable share debate was to treat the shares as equity and account for the put separately as a derivative.

Another common thread in the discussion was that Board members were unwilling to develop an approach knowing at the outset that they would have to provide exceptions from the basic principles. They saw the perpetual approach as the best opportunity to avoid such exceptions.

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