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Financial Instruments: Classification and Measurement

Date recorded:

Exception from fair value measurement for some equity instruments

The staff introduced the session by first setting out the objective of the of their agenda paper, which was to address the proposed elimination of the cost exception for some unquoted equity instruments and related derivatives.

The staff briefly touched on the comments received from constituents in response to the ED's proposals to remove the cost exception. Many respondents agreed that cost does not provide useful information about future cash flows arising from equity instruments and that conceptually fair value is the right answer. Some respondents generally agreed with the removal of the cost exception. However, many others disagreed on the grounds of

  • fair values being less reliable in certain cases;
  • the cost and difficulty in determining fair value on a recurring basis; and
  • difficulty in verification and impaired comparability due to subjectivity of measurement

One of the staff members set out the feedback they had received first hand from constituents which indicated that the concern about the removal of the cost exception came mainly from companies that had occasional or limited number of investments in unquoted entities. Their concerns included:

  • lack of guidance on fair value measurement of equity instruments;
  • lack of in-house expertise to perform valuations;
  • lack of reliable input data to perform valuations; and
  • questions over the usefulness of fair values.

The staff then set out the options that they feel the Board has for finalising the proposals as:

  • Option 1: Finalise the proposals without modification, but consider whether there are ways in which the cost to preparers might be reduced.
  • Option 2: Keep the existing exception in IAS 39 without modification.
  • Option 3: Keep the existing exception in IAS 39 with modifications.

Before handing over to the Board for their comments the staff set out their recommendation to measure all equity investments and derivatives at fair value and to remove, as proposed in the ED, the cost exception that currently exists in IAS 39.

In their discussion most Board members acknowledged that this was a difficult area to address because the issue is more about the cost/benefit analysis rather than the conceptual question about the relevance of fair values as there is agreement that fair values is the most decision useful measure for equity instruments and related derivatives.

Some Board members expressed support for the staff's proposals (ie Option 1) including support for additional guidance in the standard about materiality considerations and guidance on the efforts an entity would be required to go to in order to derive a fair value. In cases where fair value simply could not be determined with any degree of reliability, a limited number of Board members proposed that the investments should not be recognised at all with the investment amount written off as an expense.

Some other Board members expressed support for retaining the existing cost exception that exists in IAS 39 but with additional detailed guidance on when it would be appropriate in order to address the perceived current inappropriate over-use of the exception (Option 3). The rationale put forward for this was that the cost in certain circumstances outweighed the benefit.

The debate moved on to considering where the line should be drawn if there were to be some kind of relief from fair valuing certain equity instruments and in those circumstances what relief should be available.

In defining the subset of instances where it could be appropriate to use a measurement other than fair value the Board considered materiality of the investment, the practicability of calculating fair value, and the business model of the reporting entity. Some Board members questioned whether any exception to fair would be only for strategic investments while others noted the difficulty in defining strategic investments.

It was generally agreed that all equity investments held by certain entities such as financial institutions, private equity houses and venture capitalists should always be measured at fair value. Further, all quoted equity investments, all equity investments held for trading, all material equity investments, and all equity investments for which it is practicable to derive fair value should also be measured at fair value. There was some debate as to how materiality would be defined for this purpose with some Board members stating that they did not think an exception based on materiality would be operational or indeed necessary leaving the main test as one of practicability of determining fair value.

For the subset of unquoted equity investments for which it could be appropriate to use a measure other than fair value the potential alternative measures included valuations based on management judgement, percentage of net assets, and cost, all of which could also be equivalent to fair value in certain cases.

It was agreed that the staff would come back with an alternative proposal for consideration that stated that the principle measurement for equity investments would be fair vale except in certain limited cases where an alternative may be used. This alternative would also include proposals on what the alternative measure would be.

The staff then moved on to their second question in this area about whether there should be certain voluntary relief from determining fair values of equity investments for interim reporting.

Questions were raised as to which equity investments this relief should apply to. The Board were asked to vote whether they would accept this relief for the subset of unquoted equity investments discussed above. All but four Board members voted that they would support such a relief.

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