The Boards hosted an education session in which members of the telecommunications industry presented concerns they have with the Board's proposals in the exposure draft and subsequent decisions to date. The Boards were also presented an opportunity to ask questions to the industry participants.

The presentations were made by representatives from Deutsche Telekom, TeliaSonera and Sprint Nextel (representing the US wireless industry also including AT&T and Verizon).

In the telecommunications industry, providers will often offer customers subsidised handsets when the customer enters into a minimum term service contract. These entities will typically incur losses on the handsets (the cost will exceed the price paid by the customer) in order to secure the periodic service contract of the customer as the profit margin in the service contract will more than recover the loss incurred on the handset.

Two of the presenting groups had fairly similar concerns with the proposals feeling they would (1) not accurately portray the economics of the transactions involved, (2) reduce comparability within the industry, (3) result in increased complexity because of the requirement to assess at the contract level, and (4) result in significant implementation costs. With respect to the economics not being accurately portrayed, they felt that the proposed model and its allocation of revenue to performance obligations based on the relative stand alone selling price would misrepresent revenue when the customer acquires the handset (when in fact the entity has incurred an economic loss at that point) and would then understate revenue throughout the contract life. However, the other participant's concerns on this issue were not as significant as their current revenue recognition approach aligns closer to the proposals in the exposure draft (they allocate the discounts offered in a bundling service arrangement based on their relative fair values).

All three participants had some concerns over the requirement to assess at the individual contract level. The one participant using an approach that aligns to the current proposal currently allocates any associated discount using a portfolio approach rather than a specific contract approach. The participants noted that contracts within the initial contract period are often modified. The participants also noted that their billing systems were tied into the accounting systems at an aggregated level and not at the individual contract level. As such, the costs to implement the proposals would result in significant systems overhauls.

No decisions were made during this session.

Measurement of policyholder participation

The Boards discussed how to apply the principle that an insurance contract is measured using the expected present value of the fulfilment cash flows when those cash flows results from contractual participation features and the cash flows have a dependency from asset values held in participating funds. The two papers presented for this discussion included background information and the following recommendations to the Boards:

• The cash flows expected to result from the policyholder participation should be included in the insurance liability on the same basis as the measurement of the underlying items in which the policyholder participates;
• The measurement of the participating contract should reflect the asymmetric risk sharing between the insurer and the policyholder resulting from the minimum guarantee;
• The changes in the insurance contract liability shown in the statement of comprehensive income should be consistent with the presentation of the changes in the items from which the participating liability depends on; and
• The same measurement approach should apply to unit-linked ("UL") and participating contracts ("par").

During its presentation of the recommendation paper, the staff noted that the main difference between UL contracts and those with participating features is often associated with the nature of the asymmetric risk sharing between the insurer and the policyholders. UL contracts directly pass investment performance through to policyholders using an equivalent to a total return swap approach whereas par contracts frequently feature minimum guarantees as well as only sharing a percentage of the investment performance (for example 90%).

It was noted that the feedback received on the exposure draft ("ED") proposal for UL to amend the treatment of treasury share and owner occupied property was positive. Because of the existence of the same accounting mismatch for par business, respondents asked if the consequential amendments could be extended beyond assets backing UL contracts liabilities. The staff has identified some issues with this option, e.g. deferred tax assets cannot be measured at FV, thus proposing to amend the ED approach to reduce the accounting mismatch by measuring the liability using the same attribute as underlying item, i.e. if the underlying assets are measured at cost or they are not recognised (e.g. treasury shares), the measurement of the liability relating to this asset should also be measured in the same way. The paper gives an example of this proposal in paragraph 25.

The FASB noted that they would prefer to value the liability using the building block approach, i.e. project cash flows based on the contractual obligations of the insurer and use the fair value of the underlying items if that is what affects the benefits payable to the policyholder. They acknowledged that this creates an accounting mismatch in the situation where the underlying item is measured on a different basis or it is not recognised at all. They referred to this approach as a two step approach as you then deal with the mismatch in a second step which could produce some amendments to the accounting treatment of the assets. In conclusion FASB appeared more aligned with the ED proposals than with the new staff recommendations.

The IASB on the other hand generally supported the staff recommendation to measure the par contracts' liability on a basis consistent with the underlying items. This would eliminate the undesired accounting mismatch; the remaining source of volatility in the financial statements would come from the economic mismatch as markets change.

Some Board members asked for FV disclosure requirements as there would still remain claims against unrecorded FVs.

Following the IASB's discussions and its general agreement with the staff, the FASB confirmed their preference for measuring the liability under the building blocks approach without modifications i.e. that the cash flows should be defined based on what is promised to the policyholder. The decision on what to do with the potential accounting mismatch should be looked at as a second step.

As votes were taken the FASB unanimously rejected the staff recommendation whilst a large majority of the IASB members supported the staff recommendations.

The IASB held an education session in preparation for next week's joint meeting. The FASB staff joined the meeting by teleconference. No decisions were made by the Board at this meeting.

Distinguishing between lease accounting approaches

The IASB discussed whether to include certain elements and indicators with the guidance in paragraphs 7-12 of IAS 17 to distinguish between finance and other-than- finance leases. The staff discussed a definition of an other-than-finance lease and proposed to include a specific definition (rather than just the inverse of a finance lease). Most Board members supported an enhanced definition but some felt uncomfortable with the staff's proposed wording. Many Board members also acknowledged that they don't agree with having two types of leases. The Board also discussed the indicators and again there was disagreement about the specific indicators that should be applied to determine the type of lease. Some Board members expressed concern that the indicators will be applied as bright-lines like today.

Lessee accounting – other than finance lease

The IASB discussed the other than finance lease model for lessee accounting with a focus on how the right-of-use asset should be depreciated. Several IASB members expressed concern about the operationality of the model and others questioned the conceptual basis of depreciating an asset using an annuity approach. Some Board members thought that other comprehensive income should be used to address the difficulties in the model. Also, some Board members expressed a view that the cut for determining the type of lease should be based on the nature of the asset (e.g., equipment versus real estate). A majority of IASB members indicated that they would drop the other-than-finance lease approach entirely. These IASB members would favour a single approach for lessee accounting where the profit and loss would be recognised on an accelerated basis consistent with the exposure draft.

Lessor accounting: Finance leases – measurement and presentation

The IASB discussed different aspects of the measurement and presentation of finance leases, with a particular focus on the measurement of the residual value and the presentation of the lease receivable and residual assets. Specifically, the IASB discussed whether the entire asset should be derecognised and whether residual asset should be recognised at a discounted amount and subsequently accreted over the lease term using the rate the lessor charges the lessee. Also, in relation to presentation, the IASB discuss whether a lessor should present the lease receivable and the residual asset together as one amount in the statement of financial position as an investment in leased assets. The lessor should also disclose in the notes to the financial statements, the portion of that investment in leased assets that relates to the residual asset.

Lessor accounting – other than finance lease

The IASB discussed three possible approaches relating to lessor accounting: (1) performance obligation approach with net presentation, (2) retain current operating lease accounting and (3) derecognition approach. The IASB had expressed mixed views with some supporting retaining current operating lease accounting while a slight majority supported the derecognition approach. The FASB staff indicated that the FASB appeared to support either the performance obligation approach or retain current operating lease accounting.

Accounting mismatch and volatility overview

The staff indicated that the majority of the papers to be presented were for discussion and that the results of these discussions would be taken into consideration, along with the discussions of the Insurance Working Group to be held on 16 May 2011, to determine the direction of the staff's work in this area. No decisions were asked at this meeting.

The staff further indicated that these discussions were held separately with the IASB and the FASB. In the staff's view, the individual Boards should consider this issue separately as a result of the differences in presentation, particularly on recycling and on the presentation of the assets backing the insurance contracts.

Reducing accounting mismatches in profit or loss through presentation

The staff analysed the sources of the accounting mismatches that arise when insurance assets and liabilities are measured on different bases. The staff recommended that an insurer should be permitted to recognise within other comprehensive income the differences arising between the original discount rates at contract inception and the current discount rate determined based on market interest rates observed at the reporting date. This option should be granted if that approach would eliminate or substantially reduce an accounting mismatch. The staff further recommended that the option should be applied by portfolio.

Some Board members felt that enough action had been taken to address volatility and that this proposal would be "a step too far". In particular, Board members mentioned:

• the proposals agreed by the IASB (but not the FASB) on 11 May for participating contracts; and
• the decision to use a top-down method to determine the discount rate.

In addition, Board members expressed concerns that this proposal could potentially conceal real economic mismatches or that it would only shift genuine accounting mismatches into other comprehensive income rather than addressing the cause of the mismatch. Other Board members raised concerns that if insurers were permitted to move volatility into other comprehensive income, then other industries would need to be treated the same way and other accounting standards would need to be modified to permit this.

Other Board members supported the staff recommendation. They raised the point that the Board has applied essentially a similar approach for pension accounting, and that the accounting standards should aim for a consistent approach to the treatment of variances and the use of OCI.

Support for the staff proposal was also motivated by a preference for addressing volatility in the income statement rather than amending asset valuation rules (as proposed in Paper 6A). Overall, there did not seem to be a significant amount of support for the staff recommendation.

Implications of using OCI to reduce accounting mismatches in profit or loss

The staff noted this topic only applied if the Boards eventually supported the staff proposals regarding reducing accounting mismatches in profit or loss. The staff introduced the paper and made a number of observations, but no recommendations. Key issues discussed were:

• how to apply a locked in approach to insurance contracts with floating interest rates when the difference between the current discount rate and the locked-in rate is presented in OCI;
• whether an onerous contract test should be required where a locked-in discount rate is used; and
• how to show the effect of duration mismatches that may be concealed by the use of OCI.

The majority of Board members seemed reluctant to specify a preference before hearing the comments of the Insurance Working Group on these issues.

Among the Board members who expressed a view several were opposed to the direction of the staff observations for guarantees and for onerous contracts. They noted that this approach would allow changes in options and guarantees, representing true economic mismatches, to be recognised in OCI. Some Board members were also concerned that this use of OCI may necessitate revisions of other standards in order to maintain a level playing field across other industries as well as consistency within IFRS.

Assets backing insurance contract liabilities

The staff asked whether the IASB should change the requirements of IFRS 9 to present the gains and losses on financial assets backing insurance contract liabilities within other comprehensive income rather than in profit and loss (either changing general requirements of IFRS 4 or specifying different requirements for assets backing insurance contracts within the insurance standard). The staff presented the paper to the Board and recommended that IFRS 9 should not be changed.

Overall, the Board members were supportive of the staff recommendation, although no official vote was taken.

As they expressed their support for the staff recommendation Board members commented that they believe earnings management through realisation of gains should be avoided and this could be achieved effectively if the available-for-sale category was not reintroduced. Some members raised concerns that if previous papers should be implemented, it could lead to an uneven playing field across different industries and inconsistent treatment of similar transactions (with some going through profit and loss and others going through OCI) unless changes to IFRS 9 were made. That said, they still supported the staff recommendation.

Other Board members were concerned that if the use of OCI proposed in Paper 6B was rejected, the mismatch between asset valuations and liability valuations would remain, and would necessitate revisions to the measurement rules for the assets backing the insurance contracts in order to address volatility. In particular, these members were opposed to implementing separate measurement rules (either within IFRS 9 or as an override of IFRS 9 within IFRS 4) for the assets backing insurance contracts.

Hedge effectiveness assessment

Feedback provided during the Board's outreach activities and comments received from the hedge accounting exposure draft identified that constituents were very supportive of the removal of the 80-125% brightline threshold and the required quantitative retrospective hedge effectiveness test. Additionally, most supported the introduction of a qualitative hedge effectiveness assessment to qualify for hedge accounting. However, constituents had some concerns with the exposure drafts' objective based hedge effectiveness assessment proposals.

The staff's analysis attributed some of that concern to the introduction of new terms and concepts that constituents were not previously familiar with. However, the staff also acknowledged that some of the proposals were being misinterpreted or had unintended consequences. For example, some constituents felt that the proposed requirement that a hedging relationship produce an unbiased result' that minimises expected ineffectiveness' would require entities to find the perfect' derivative rather than a derivative that is most economical and which meets the risk management objective (i.e., effectively replacing the 80-125% effectiveness threshold with a 100% hedge effectiveness requirement). Some respondents also noted that the effectiveness test requirement that no expectation that changes in the value of the hedging instrument will systematically either exceed or be less than the change in value of the hedged item' could be problematic for late hedges' when the hedging relationship is entered into at a point after inception of the derivative hedging instrument such that it has an inherent fair value other than nil.

To address the concerns over misunderstanding, lack of clarity and potential unintended consequences, the staff recommended supplementing the term other than accidental offsetting' by clarifying that a hedging relationship would have to meet the following two criteria: (1) that there is an economic relationship between the hedged item and the hedging instrument, and (2) the effect of credit risk does not dominate the value changes that result from the economic relationship (i.e., the effect of the changes in the underlying). The staff also recommended replacing the guidance in the exposure draft on unbiased hedge', minimising hedge ineffectiveness', and the entity has no expectation that changes in the value of the hedging instrument will systematically either exceed or be less than the changes in value of the hedged item such that they would produce a biased result'. Instead, the guidance would be replaced by adding criteria that an entity's designation of the hedging relationship shall be based on (1) the quantity of hedged item that it actually hedges, and (2) the quantity of the hedging instrument that it actually uses to hedge that quantity of hedged item. Additionally, guidance would be included that an entity shall not designate a hedging relationship such that it reflects a deliberate mismatch between the weightings of the hedged item and the hedging instrument that would create hedge ineffectiveness in order to achieve an inappropriate accounting outcome.

The Board began its discussion by clarifying that this discussion on hedge effectiveness was solely in the context of getting into hedge accounting and not in the context of measuring hedge ineffectiveness. The Board was generally supportive of the staff's recommendations although there were several comments made on drafting suggestions. Some Board members preferred the usage of anchor' or umbrella' terms (such as other than accidental offsetting' and unbiased result') feeling that principles based standards require usage of such terms and that overly describing the concepts will only result in additional requests for clarification. However, other Board members felt that adding additional clarity was necessary to ensure the effectiveness criteria were applied as intended by the Board.

The Board had a discussion on whether the revised criteria as recommended by the staff represented a loosening or tightening of 1) the current requirement under IAS 39 and 2) the proposals in the exposure draft. Some Board members felt that the revised criteria represented a tightening of the criteria over both the 80-125% threshold and the exposure draft proposals. Other Board members had concerns over expressing the revised criteria as tightening the requirements in IAS 39 because they felt the current requirements were overly punitive. The staff suggested that the revised criteria could not fairly be compared to the current IAS 39 requirements as looser' or tighter' because of the arbitrary results that sometimes occur with the 80-125% threshold. However, the staff acknowledged that the revised criteria should help to tighten the requirements over those in the exposure draft and help to address the concerns of those who interpreted the proposals as allowing inappropriate hedging relationships to qualify for hedge accounting.

Ultimately, the Board supported the staff recommendation subject to wording modification the Board will provide to the staff on the revised hedge effectiveness criteria.