Conceptual framework — Measurements and elements of financial statements (IASB only)

Date recorded:

The IASB discussed an early draft of sections of a Discussion Paper (DP) on the Conceptual Framework addressing measurements other than cost or fair value and certain elements of financial statements (liabilities).


The IASB previously discussed measurement bases, including general principles for measurement and when different measurement bases (e.g., cost, fair value and other bases) may be appropriate. At this meeting, the IASB discussed measurement methods in financial statements other than cost and fair value. The discussion focused on descriptions of measures based on estimated cash flows, possible high-level principles for using other cash-flow-based measures, considerations in determining when to use other cash-flow-based measures and current market prices other than fair value and when they might be useful.

Measurement based on estimated cash flows

The staff first asked the Board to consider not whether to use a fair value estimate, but if a fair value estimate has been determined not to be appropriate, which factors a cash-flow-based measurement should consider and from whose perspective (e.g., undiscounted estimates of most-likely cash flows, value-in-use and other entity-specific measurements, fair value based or partially updated measurements and other discounted cash flow measurements). The staff believed the IASB must first decide what the measure is intended to represent before deciding what factors should affect the measurement. The staff suggested the appropriate measurement method (what information a measure is intended to represent) for a particular asset or liability could depend on how the entity will realise value of an asset or what payment or performance a liability will require of the entity.

The staff paper appeared to lead to more questions than answers, as Board members repeatedly questioned the scope of what they were being asked to consider. In particular, Board members saw the staff paper as presenting a series of alternative cash-flow-based measures without specifying when such measures should be used. They believed the paper should address questions such as when is entity-specific value more appropriate than market value. Similarly, Board members asked questions such as when is a fair value estimate not appropriate and whether cash-flow-based measurement is intended to be a proxy for fair value when fair value is not available. Some Board members believed the measurement objective should always be to provide an approximation of fair value, but others did not believe measurement should be a surrogate for fair value in all cases; pointing to examples such as fulfilment value in the insurance project and a deprival value methodology to measurement, which are not necessarily indicative of fair value in the eyes of the market. Much of the discussion regarding the measurement objective was based on perspective, as most Board members supporting cash-flow-based measurement as a proxy for fair value were analysing asset valuation, while those who did not view all measurements as a proxy for fair value were primarily discussing liability valuation.

In response, the staff noted it was not the intention of this paper (or the DP) to answer questions about which measurement methods are appropriate and when they should be used. Instead, they hoped to gather feedback from constituents about the different alternatives with a view to develop more specific views in a future exposure draft on the Conceptual Framework. However, the staff acknowledged the need, within the DP, to more fully describe the scope of the work being undertaken, including specifying the questions the DP is not intending to address.

Board members also requested structural and editorial changes to the agenda paper – which will form the basis for the DP. Many of those comments were an attempt to more clearly define the inputs to cash-flow-based measurement relative to the outcomes achieved by the measurement models, but others were based on beliefs regarding the appropriateness of cash-flow-based measurement and the inputs which should be considered. The staff noted that it would consider this feedback in drafting.

What to consider in constructing a cash-flow-based measure

The staff asked the Board what should be considered in constructing a cash-flow-based measure. The staff believed that the inputs (e.g., amount and timing of future cash flows, time value of money, etc.) used in a fair value estimate provide a comprehensive starting point for thinking about other cash-flow-based measures. However, the staff suggested the DP should raise the following general questions in considering other factors relevant to a cash-flow-based measure:

  1. Should cash-flow-based measures reflect the uncertainties in the amount and timing of a cash flow (or series of cash flows) or a single possible amount (or series of amounts)?
  2. Should the measurement of liabilities reflect the possibility that an entity may not be able to settle its liabilities when they are due (the entity’s ‘own credit’)?
  3. Should cash-flow-based measures be discounted and if so, at what rate or rates?
  4. Should cash-flow-based measures reflect the amount market participants would charge for bearing the risk embodied in the uncertain cash flows?
  5. Should cash-flow-based measures reflect the effects of other factors such as illiquidity premiums or discounts if they are identifiable?
  6. Should the estimates and assumptions underlying cash-flow-based measures reflect the reporting entity’s perspective or market participants’ perspectives?
  7. Should all the above estimates be current (i.e., updated at each reporting date), or should some or all of them be locked in (i.e., not updated)?

The staff proposed the DP would provide some general discussion behind each of these questions, however, the DP would not attempt to answer the questions. Instead, it would only ask respondents for suggestions and information.

Consistent with earlier discussions, many Board members feared the DP would have the unintended consequence of suggesting a broad suite of measurement techniques are available without providing insight as to when such measurement techniques/inputs should be used. However, considering the questions proposed to be included in the DP and the related discussion that followed each question, Board members provided a number of specific questions/concerns, including:

  • A fear about the specificity of particular questions and the underlying interaction with IFRS 13 Fair Value Measurement. In particular, one Board member saw the questions proposed to be included in the DP as subsidiary to more basic questions and feared the proposed questions would result in inappropriate and unnecessary feedback from constituents. She also noted the questions should be internally linked to other questions in the document and IFRS 13 (or other IFRSs) for purposes of demonstrating overall cohesiveness.
  • Overall concerns with the staff’s discussion of ‘own credit’ in the staff paper. Many comments related to semantics, such as characterising movements in own credit as gains or losses since some viewed the characterisation as perspective driven, but some Board members believed more detail about the nature of own credit adjustments was required in the DP, including discussion of wealth transfer and characterisation of gross and net gains.
  • While many supported the staff’s discussion (in the staff paper) of the role of discounting in measurement, one Board member believed the discussion comingled two independent issues – time value of money and uncertainty of cash flows. She thought time value should be emphasised in the discussion of discounting, while uncertainties of cash flows was a measurement technique (a mechanic for achieving the objective) which should be discussed separately.
  • A concern that the staff’s discussion of adjustments for bearing risk suggested risk adjustments for insurance contracts were inappropriate. The staff paper focused on identifiable and observable prices for bearing risk – failing to discuss when prices are not observable (e.g., in an insurance contract). The staff noted they did not intend to suggest that prices must be identifiable and observable, but rather, highlighted observations when such cases are present.

No specific vote was taken as to the inclusion or elimination of any specific questions and/or discussion of the topics included in the staff paper for purposes of drafting the DP. However, the staff noted it would consider Board feedback in drafting the DP.

The staff also asked the Board whether it preferred that the DP include discussion about current market prices other than fair value (e.g., other possible market prices that are not included in the definition of fair value such as different markets and different units of account). The staff paper highlighted a couple of examples as well as avenues the Board may consider in measurement. Without debate, the Board agreed that it was a relevant consideration, and thus, should be considered in the DP.

Elements of financial statements

The IASB discussed guidance to support the definition of a liability – specifically seeking to clarify the role of economic compulsion in identifying obligations and the difference between economic compulsion and a constructive obligation.

Distinguishing constructive obligations from economic compulsion

Previous Board statements have suggested that economic compulsion – where an entity is regarded as being economically compelled to take an action since a particular course of action is so economically advantageous, or less economically disadvantageous, than any other available alternatives - does not, in and of itself, create an obligation/liability. However, this general principle does not exist in the Conceptual Framework and certain perceived exceptions exist in existing IFRSs.

Conversely, constructive obligations – which are defined or alluded to in paragraphs IN3 of IAS 37 Provisions, Contingent Liabilities and Contingent Assets, IN6 and 4(c) of IAS 19 Employee Benefits and 41 of IFRS 2 Share-based Payment – can give rise to a liability.

Given difficulties in distinguishing constructive obligations from economic compulsion, the staff noted that it is difficult for practitioners to judge whether and to what extent an entity’s past practices, policies or statements are sufficient to have created a valid expectation among other parties that the entity will accept specific responsibilities.

In an effort to improve comparability and distinguish constructive obligations from economic compulsion, the staff suggested two alternatives:

  • adding further guidance to support the definition of a constructive obligation in the Conceptual Framework (the additional guidance would emphasise that for an entity to have a constructive obligation, (a) it must have a duty or responsibility to someone other than yourself, (b) the other party must be one who would benefit from the entity fulfilling its duty or responsibility or suffer loss or harm if the entity fails to fulfil its duty or responsibility and (c) as a result of the entity’s past actions, the other party can reasonably rely on the entity to discharge its duty or responsibility); or
  • limiting the definition of a liability in the Conceptual Framework to obligations that another party could enforce against the entity.

Alternatively, the Board could elect to not address this matter in the DP/Conceptual Framework.

Board members universally supported adding further guidance to support the definition of a constructive obligation in the Conceptual Framework, as outlined above. They acknowledged the need for clarifying guidance but found the latter proposal of limiting the definition of a liability to obligations that another party could enforce as being too prescriptive. They also noted that the proposal of adding clarifying guidance is not expected to undermine requirements in existing IFRSs.

Effect of economic compulsion on contractual obligations

The staff noted that questions about economic compulsion arise in situations where the entity’s future actions are constrained by a legal mechanism such as a contract (i.e., an entity has options under a contract but economic compulsion will limit the entity’s freedom to exercise its options). The staff noted that several IFRSs provide guidance on the factors that an entity should take into consideration in assessing the substance of contractual rights and obligations and there are consistent principles underpinning this guidance that may be useful to include in the Conceptual Framework to clarify the role of economic compulsion in assessing contractual rights and obligations. Those principles include:

  1. an entity should report the substance of a contract;
  2. a group or series of contracts that achieves, or is designed to achieve, an overall commercial effect should be viewed as a whole;
  3. all terms—whether explicit or implied —should be taken into consideration;
  4. terms that have no commercial substance should be disregarded.
  5. one situation in which a right (including an option) has no commercial substance is the situation in which it is clear from the inception of the contract that the holder will not have the practical ability to exercise the right.
  6. if, after disregarding options with no commercial substance, an option holder has only one remaining option, that option is in substance a requirement.

The Board discussed the possible inclusion of some or all of these principles in the Conceptual Framework. Multiple Board members expressed specific concerns with the principles. Some of those concerns included:

  • A lack of clarity regarding the definition of ‘commercial substance’. The staff noted that IFRS 10 Consolidated Financial Statements and IFRS 4 Insurance Contracts provide guidance on commercial substance, although the guidance was not specifically aligned.
  • A belief that the ‘commercial substance’ principle should be bifurcated to distinguish recognition and classification considerations. Namely, this Board member believed the principles should first consider whether a claim exists (recognition), and if so, the nature of that claim (classification – in particular, for classification as a financial liability or equity instrument when applying IAS 32 Financial Instruments: Presentation), with economic compulsion possibly relevant to the latter.
  • A belief that the concepts of economic compulsion and constructive obligations should be linked in the proposed principles.
  • Questions about whether the proposals require reassessment, specifically in the context of whether commercial substance should be reassessed.

No specific vote was taken as to the inclusion or elimination of any specific questions and/or discussion of the topics included in the staff paper for purposes of drafting the DP. However, it was clear from discussions that further discussion was required in the DP regarding the role of commercial substance in assessing contractual rights and obligations and the relevance of economic compulsion in classification determination. The staff noted it would consider Board feedback in drafting the DP.

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