This site uses cookies to provide you with a more responsive and personalised service. By using this site you agree to our use of cookies. Please read our cookie notice for more information on the cookies we use and how to delete or block them.
The full functionality of our site is not supported on your browser version, or you may have 'compatibility mode' selected. Please turn off compatibility mode, upgrade your browser to at least Internet Explorer 9, or try using another browser such as Google Chrome or Mozilla Firefox.

Conceptual framework

Date recorded:

The Technical Principal on the Conceptual Framework project opened the session and noted that the Staff had seven Agenda Papers on the Conceptual Framework to discuss with the Board. She noted that in the first six papers, the Staff would be asking for decisions from the Board on items that could be included in the Exposure Draft of the Conceptual Framework. She further noted that in the final paper, on the distinction between liabilities and equity, the Staff would not be asking the Board to make any decisions, and that this would be a purely educational session ahead of next month, where the Staff would be asking the Board to make decisions on liabilities and equity.

 

Profit or loss and other comprehensive income

In April 2014, the IASB had discussed alternative approaches to developing profit or loss (P&L) and other comprehensive income (OCI) proposals for the Conceptual Framework Exposure Draft and had asked the Staff to develop an approach that would:

  1. Emphasise the role of profit or loss as the primary source of information about an entity’s performance; and
  2. Provide high level guidance to the IASB on how it could use OCI.

At this meeting, the Staff presented the approach developed by the Staff. To emphasise the role of P&L as the primary source of information about an entity’s performance, the Staff recommended in paragraph 45 of the paper that the IASB:

  1. Confirm the proposal that P&L should be required as a total or subtotal;
  2. Describe P&L as the primary source of information about an entity’s performance for the period;
  3. Include in the Conceptual Framework the rebuttable presumptions that the IASB must, unless doing that would undermine the relevance of P&L, require:
    1. Items of income and expense to be reported in P&L and
    2. Items of income and expense included in OCI to be recycled to P&L;
  4. Discuss the dual objective of P&L of depicting the return that an entity has made on its economic resources during the period and providing information that is helpful is assessing prospects for future cash flows;
  5. Set out items of income and expense that could not be reported outside P&L as set out in the Agenda Paper.

To provide guidance to the IASB on how it could use OCI, the Staff recommended in paragraph 57 that guidance should be provided on the use of OCI by extending the description of the rebuttable presumption to refer to dual measurements. That is, the IASB could require, or permit, an item of income and expense – or a component of that item – to be reported in OCI only in limited circumstances when the IASB conclude that doing so would enhance the relevant of P&L as the primary source of information about an entity’s performance for the period. Such circumstances would include (but would not be limited to) cases when the IASB conclude that one measurement basis is appropriate for an asset or a liability in the statement of financial position and another measurement basis is appropriate for P&L. In such cases, the resulting difference would be reported in OCI.

The Senior Technical Manager introduced the Agenda Paper and asked the Board members whether they had any comments and whether they agreed with the Staff recommendations in the paper.

One Board member noted that the Agenda Paper started from the assertion that P&L was the most relevant measure of performance, and noted that the Board needed to explain why they believed that was the case. He noted that there was some discussion in Section 8 of the Discussion Paper with respect to the reasons for the assertion and that this should also be included in the Exposure Draft. He also suggested asking analysts why they believed P&L was so important and introducing some of their responses into the discussion in the Exposure Draft.

The Chairman suggested to the Staff that they could flesh out what was in the Discussion paper and include this in the Exposure Draft.

Another Board member expressed concern that the Board was neither defining primary nor performance. He noted that he did not believe that just stating that 'P&L is the primary measure of performance' was achieving anything, as both current and future Board members would have different ideas of what this meant. Accordingly, there would end up being no consistency over what went into P&L and OCI. He also questioned whether, if P&L was the primary measure of performance, OCI was still performance but just secondary, or not performance at all. The Senior Technical Manager responded that even if performance was not defined, there would still be pressure put on the Board when making subsequent decisions to explain why a particular decision would enhance the relevance of P&L. The Chairman agreed with this comment and noted that performance was extremely complex and multifaceted and went beyond just P&L, so was not sure that the Board was going to be able to define performance. He added that, if the Board believed P&L was the primary indicator of performance, then there should be a pretty high threshold for something to be taken to OCI, and that this was a step forward. The Senior Technical Manager responded to a previous comment, noting that the Staff did not intend to make P&L the only measure of performance. She added that the Staff would look to address this point through looking at the language being used in the Exposure Draft.

Another Board member noted that the Staff’s proposals were a huge step forward. She noted that just having a statement that there was a rebuttable presumption that all items of income and expense should be recognised in P&L (principle 2) would be a huge help. She noted that what was a significant change in the perceived philosophy of the Board was principle 3 (that an item recognised in OCI must subsequently be recycled to P&L) combined with principle 2, because the philosophy for many years had been that comprehensive income was the key figure; items of income or expense should only be displayed once in the statement of comprehensive income and, therefore, there was no recycling. She noted that what these principles were saying in combination was that everything should go through P&L once rather than through total comprehensive income once.

Another Board member also believed it was important for the Board to define performance. He noted that the obvious answer for many people as to what performance was is 'changes in net assets other than those transactions with shareholders'. This would mean that OCI was a measure of performance, but not a primary measure of performance, and it should be looked at. He believed it was important for the Board to highlight this point in the Conceptual Framework to point out to users of financial statements the importance of OCI, as there is currently a lot of evidence that suggests that people do not look at OCI.

Another Board member believed the proposals in the Agenda Paper represented significant progress and formed the right basis for the Board to move forward in developing the Exposure Draft. She noted that the conclusion that recognition in OCI was the exception was an important statement. She noted that finding a definition of performance appealed logically, but acknowledged that the Board would probably not be able to make much further progress at this stage.

Another Board member noted that what people thought should be included in P&L would depend on what their view of the entity’s performance was, and particularly what performance for the period was. She noted that even if the Board did not define performance, some of the other decisions that may be made in other areas (for example, on the business model) might give the Board some things to think about that would help in deciding whether something might be relevant in the period or not. Following on from earlier comments with respect to the meaning of OCI given the prominence given to P&L, she questioned whether the distinction that was trying to be made was that P&L was about performance in this period and OCI was a sort of broader period of performance.

The Chairman responded that the terms currently used were that one measure was important for current period P&L and the other was important for the balance sheet. The Board member noted that the distinction worked and helped the Board work out what should be in P&L for this period by thinking about the business model. For example, if the business model was trading, then it would be relevant to put all fair value movements in P&L because they related to the period, whereas if the business model was hold to collect or sell, that changed what was relevant to the performance of the period.

Another Board member noted that what the previous Board member was talking about was something that should be discussed when the Board talked about the dual objective of P&L – depicting the return the entity had made on its economic resources during the period and providing information that was helpful in assessing the prospects for future cash flows.

The Senior Technical Manager noted that this was an area that the Staff could look at further. She noted that in this Agenda Paper, the Staff did not intend to put emphasis in the context of OCI, because what happened in OCI was still something that happened during the period but might not be as relevant to an entity’s performance as what was in P&L. Accordingly, the Agenda Paper focused on the primary source of information versus a sort of secondary source of information.

In response to the earlier discussion around defining performance, another Board member pointed out that no one had ever come up with an agreeable concept of performance, so he would not agree with the Board pursuing developing a concept of performance, but did support stating why the Board believed P&L was the primary measure of performance.

Another Board member commented on several items in the Agenda Paper. He noted that he did not like the idea of using a rebuttable presumption in the Conceptual Framework as it seemed more like a standards level requirement. He also commented on paragraph 45(e), which lists a number of items that could not be reported outside P&L, noting that he did not believe this was helpful and could create more confusion. He noted that using a few examples could be okay, but that the Board should steer away from including a comprehensive list in the Conceptual Framework.

Another Board member reiterated the fact that it would be useful to expand on what performance was. He also noted that a key question in the discussion was 'what does the Board actually think of OCI as being?' and suggested that it could be answered as

  • P&L was about current period performance and the primary statement because people who are observing performance are primarily observing the performance in the current period; and
  • OCI was informative about future performance.

He observed that in the past the Board had discussed the need to increase the focus on OCI, but acknowledged that it would be very difficult to get people to look at OCI if the Board did not know what it was they were describing as OCI. He noted that the worst argument that could be made would be to say that one would need to look at OCI because it would be the only way to really understand performance, as it would detract from saying that the primary source of performance was P&L. He noted that he believed the best way to achieve this would be to say 'the source of performance in this period is P&L, the information about the future performance is in OCI, that is why OCI needs to be looked at'.

Several other Board members noted that they did not agree with distinguishing OCI from P&L by using a current/future performance notion and suggested that this was not mentioned in the Exposure Draft as it could lead to a number of difficulties.

Another Board member noted that it was important that the Board was conceptually clear on what they were trying to achieve with respect to recycling. He noted that in the past that Board had the philosophy that, if an item was in the Statement of Comprehensive Income, the gain or loss had been recognised and had been included in a performance measure and should not be included again – so the same profit was not recognised twice. He also noted this was consistent with how he interpreted the definitions of income and expense, noting that an expense arises when there are changes in net assets, and if a recycled amount is taken to P&L there is no change in net assets. Accordingly, he noted that if the Board was to bring in recycling as a clearer concept, they would need to think about the definitions of income and expense. He noted that if the Board was going to move from a position where everything was recognised once in the Statement of Comprehensive Income (and a presumption of no recycling) to a presumption that everything was recognised once in P&L (so full recycling), the Board would need to be clear that they had made that philosophical change and not just vaguely say 'sometimes recycle, sometimes do not'. He noted that he did not support where the Board was at on recycling as it was too vague, and suggested that either the Board said nothing (and revisited in the Financial Statement Presentation project) or was more specific.

The Chairman brought the discussion to a close. In summarising, he noted that there were some Board members who think thought the Board should do more to try and define performance, and he encouraged the Staff to do more in this area, but acknowledged that this was going to be very difficult and that the broader principles proposed by the Staff were at least helpful.

He identified two items that he believed members felt uncomfortable with. The first item was the need for it to be made clear that OCI was not meaningless and that it can contain important secondary information, and asked the Staff to write something to this effect. He also noted that there appeared to be a lot of discomfort around the rebuttable presumption of recycling.

The Board members voted on the Staff recommendations as follows

  • All sixteen Board members agreed with the Staff recommendation in paragraph 45(a).
  • Fourteen Board members agreed with the Staff recommendation in paragraph 45(b).
    Several members reiterated the comments that had been raised earlier in the discussion with respect to the need to explain why the Board considered P&L to be the primary source of information.
  • Eleven Board members agreed with the Staff recommendations in paragraph 45(c)(i).
  • Ten Board members agreed with the Staff recommendations in paragraph 45(c)(ii).
    The Chairman noted that the grounds for rebutting the presumption should not be solely in the absence of a practical way of doing so, but that recycling could jeopardise the integrity of P&L.
  • Fourteen Board members agreed with the Staff recommendation in paragraph 45(d).
    A Board member questioned whether the Staff were going to include an objective of comprehensive income or OCI, and noted that it seemed equally applicable to OCI. The Senior Technical Manager responded and noted that given the discussions around the need to think about OCI not being meaningless and also providing useful information, the Staff would consider it. Another Board member noted that if stewardship was reintroduced in the Conceptual Framework, meaning that management was accountable for all resources and all claims in an organization, then excluding OCI here would not give a comprehensive depiction of their stewardship.
  • There were a number of comments made by Board members with respect to the use of a list in paragraph 45(e).
    The Technical Director noted that there were underlying principles in this paragraph, and noted that it might be the place for a more principles based discussion rather than a long list of items. It was concluded that the Staff would work on developing some principles to replace the detailed list of items in the Agenda Paper.
  • Thirteen Board members agreed with the Staff recommendation in paragraph 57.

 

Elements: economic resources and economic benefits

The draft definition of an asset as laid out in the Discussion Paper makes reference to economic resources. The draft definition of an economic resource refers, in turn, to future economic benefits. In this Agenda Paper, the Staff considered what guidance the Conceptual Framework should provide on economic resources and economic benefits. The Staff recommended that:

  1. The Conceptual Framework should provide examples of economic resources, along the lines of paragraph 3.5 of the Discussion Paper;
  2. The Conceptual Framework should include guidance on economic benefits, broadly consistent with the guidance in paragraph 3.6 of the Discussion Paper, and paragraph 33 of IFRS 15 Revenue from Contracts with Customers; and
  3. The purpose of depreciation and amortisation is to depict consumption of the bundle of rights that constitutes an asset

The Technical Director introduced the paper and asked the Board members whether they had any comments on the paper and whether they agreed with the Staff recommendations in the paper.

 

1. ECONOMIC RESOURCES

One Board member commented on the recommendation that the Conceptual Framework should provide examples along the lines of paragraph 3.5 of the Discussion Paper. She noted that the list of examples might have been helpful in the Discussion Paper to give people a sense of what the Board was talking about, but suggested that the Board steered away from including long lists of examples in the Conceptual Framework. She noted that the Conceptual Framework should only retain the top level description of nature (for example, enforceable rights established by contract, law or similar means), and maybe one or two examples where the Board felt the top level descriptions were too abstract. She cautioned against ending up in a situation where someone thinking about property, plant and equipment, for example, would not only have to look in IAS 16, but also in the Conceptual Framework.

The Chairman and several other Board members also agreed with this comment. Another Board member suggested that perhaps some examples could be included in the Basis for Conclusions when talking about what other standards say.

The Technical Director noted that the Staff would look again at whether they had the right level of detail in this paragraph. He noted that the Staff would look at which of the examples ((i)-(v)) could be included, and further noted that the existing Conceptual Framework had some discussion at this level of detail for some of the items. He added that this was something that would need to be assessed in drafting.

Several Board members raised concerns with respect to how goodwill should be treated in the Conceptual Framework. One Board member noted that while he agreed that goodwill should be on the balance sheet, it had always troubled him that it was defined as an asset, and questioned whether its special nature should be acknowledged in the Conceptual Framework. Another Board member pointed out the concerns expressed by respondents with respect to goodwill (as set out in paragraph 10(d) of the Agenda Paper). He noted that respondents had commented that the rationale in IFRS 3 for concluding that goodwill was an asset was not convincing, and that goodwill by itself was incapable of producing economic benefits and relied on the cash generating abilities of other assets. He suggested that this issue could be solved by providing a general definition of assets in the Conceptual Framework, with some type of exception for goodwill. A further Board member agreed with the comments made by the previous Board members and reiterated that goodwill deserved a description of the special status it had within the notion of an asset. He added that to ignore goodwill in the Conceptual Framework and just have some description in the Basis for Conclusions to IFRS 3 was not doing it justice. He further added that he would like to see some discussion in the Conceptual Framework because the residual of the IFRS 3 calculation did not meet the definition of an asset.

The Technical Director responded and noted that the Staff had suggested taking goodwill out of the list of examples to prevent this type of debate arising. He noted that the debate happened in IFRS 3, where there was an extensive discussion in the Basis for Conclusions to IFRS 3 as to why the Board had concluded that goodwill met the definition of an asset, and noted that he saw little value in reopening the debate.

Another Board member responded noting that he believed goodwill should be included in the Conceptual Framework because it was controversial. He noted that a number of people still struggled with whether goodwill should be an asset and, accordingly, noted that there was no better place than the Conceptual Framework for the issue to be addressed.

The Technical Director pointed out that the purpose of the project was to fill in the gaps in the Conceptual Framework that had caused problems in setting standards, and particularly ones that had caused problems in more than one standard. He noted that the goodwill question was predominantly a one standard issue and, therefore, did not meet the criteria for discussion. He further noted that there was an answer on goodwill in IFRS 3 and that goodwill did not need to be addressed as part of the Conceptual Framework project.

In response to the previous discussions around goodwill, another Board member cautioned that the Board was at risk of 'letting the tail wag the dog'. She noted that the Board needed to define an asset in the Conceptual Framework, and then at the standards level determine whether what was being looked at (for example, goodwill) met the definition, and added that the Conceptual Framework was not the place for this determination to take place.

Another Board member suggested that the examples in the paper should be used to stress test the definition and characteristics, but should not be included in the Conceptual Framework. She cautioned about using the Conceptual Framework as a place to tidy up things that had not made it into standards. If the Board determined, in performing this exercise, that there was something missing from a standard, they should take a note of it and address it when they next looked at the standard.

Another Board member also cautioned about including examples in the Conceptual Framework of items that the Board believed were unclear at the standards level, so that in effect the Conceptual Framework was being used to plug a gap in the standards.

The Technical Director agreed with previous comments that the examples of economic resources should not comprise a list of standards level decisions. He also noted that there were some general principles included in paragraph 3.5 that should be captured, and noted that the Staff would go away and look at the list and determine which items were more standards level issues and which were more general principles, and only include useful illustrations of the general principles where required. All Board members agreed with this approach.

 

2. ECONOMIC BENEFITS

A Board member commented on a point mentioned in the Agenda Paper, which noted that a number of respondents had asked for more detailed guidance on the notion of economic benefits. He asked how the Staff had responded to these requests, as this was not discussed in the Agenda Paper.

The Technical Director responded that the requests received were not very specific and, accordingly, the Staff did not see any obvious reason to add more guidance. He noted that the discussion in IFRS 15 was a relatively high level discussion and that it seemed strange to add more than that in the Conceptual Framework. He further noted that the Staff were not aware of any obvious areas of guidance that could be added that would be helpful at the Conceptual Framework level.

All Board members agreed with the Staff recommendation that the Conceptual Framework should include guidance on economic benefits, broadly consistent with the guidance in paragraph 3.6 of the Discussion Paper, and paragraph 33 of IFRS 15.

 

3. DEPRECIATION

The Technical Director kicked off the discussion on depreciation and amortisation. He noted that the Board’s tentative decision to change the definition of an asset had resulted in the need to change the depreciation definition so that it referred to the consumption of the economic resource (bundle of rights) rather than the consumption of economic benefits.

He drew the Board’s attention to paragraph 28 of the Agenda Paper where the Staff had illustrated the underlying concepts involved. He noted that the situation could be described in two different ways, both of which resulted in the same practical answer:

  • One has a machine with a 5 year life, and consumes the service potential of the machine as they go along; and
  • One has a series of rights and uses up the individual rights.

Several Board members commented that the first description was much more easily understood. They noted that they believed the issue was being made unnecessarily complex by talking about rights in year one, two, and subsequent years. They noted that this concept could be explained more simply by making reference to the consumption of the economic resource, rather than the consumption of the bundle of rights (year 1, year 2 etc.) comprising that economic resource. Another Board member commented that the discussion of how depreciation would be calculated based on the bundle of rights was going to a standards level discussion.

In response to the above comments by Board members the Technical Director suggested that the purpose of depreciation should therefore be to depict consumption of the economic resource that constitutes an asset, rather than the bundle of rights that constitutes an asset.

Based on the preceding discussion, the decision was made to reword the question to the Board in the Agenda Paper to "Does the IASB agree that that purpose of depreciation and amortisation is to depict consumption of the economic resource that constitutes an asset?"

Thirteen Board members agreed with the revised Staff recommendation.

 

Asset and liability definitions – executory contracts

The Senior Research Manager began by saying that the Agenda Paper examined whether executory contract asset and liabilities should be specifically included in the asset and liability definitions of the Conceptual Framework. The existing Framework did not provide concepts on this issue. The Discussion Paper said that a net asset or a net liability would arise under an executory contract if the contract was enforceable. The feedback received on this was generally positive. The Agenda Paper for this session was focused on the nature of the assets and liabilities in executory contracts. In the Staff’s view the Conceptual Framework should state that an enforceable executory contract contained a right and an obligation to exchange economic resources and that the combined right and obligation constituted a single asset or liability. This conclusion would be subject to a caveat, such that there were situations in which an entity entered into a forward contract and where the purchaser would obtain control of the underlying before the contract was actually settled. In such a circumstance an entity should gross up the rights and obligations and present an asset and a liability.

The Senior Research Manager went on to say that Staff did not expect these conclusions to have any significant impact on current standards, as the single asset would be generally lead to an amount of zero unless the contract was onerous; hence, there would be no need to recognise the net asset or liability. The conclusions had been discussed at the recent ASAF meeting where members had generally agreed that a clearer concept was needed and that a single item be recognised. However, the ASAF members had had mixed views as regards the Staff’s conclusion for justifying the single asset or liability. The Staff recommended that the Conceptual Framework should include concepts that explain the nature of the assets and liabilities. It should state that the combined right and obligation to exchange economic resources constituted a single asset or liability. The Senior Research Manager asked whether the Board agreed with this recommendation.

One Board member asked how a single asset or liability would be distinguished from a forward contract. He asked whether an executory contract could be seen as a forward or a series of forwards. The Senior Research Manager agreed that a plain vanilla forward would be an executory contract. The Board member asked whether this assessment would sustain when looking at executory contracts in the truest sense of their meaning, i.e. none of the parties had performed and no consideration had been exchanged. He said that one party paying a premium for the forward could be seen as performance. The Senior Research Manager confirmed that this would not be a wholly executory contract, but the conclusions in the paper would extend to contracts where the parties had partially performed. The key principle was that there was still an exchange that had to occur.

The Board member also struggled with the reference in the Agenda Paper that certain forwards might give the purchaser control of the resource and others might not. The Senior Research Manager said there were forwards that looked executory but, in fact, were not. One example would be a sale and repurchase agreement: After the sale had occurred, the repurchase agreement looked like an executory contract. However, in that example, the seller would have never derecognised the asset, so the repurchase could not be an executory contract as the seller had retained control over the underlying. She conceded that these kinds of contracts were rare and not the general situation. Another Board member asked whether there were other examples. The Senior Research Manager said that long-term construction contracts might be an example where there was a contract to buy an asset at a later date, but the purchaser was gaining control over the work-in-progress during construction. The Board member doubted that anything would be accounted for during the construction phase. The Technical Director conceded that he had trouble himself thinking of another example, especially in a stand-alone situation, which is why that had come up with the example of a sale and repurchase.

Another Board member felt that recognition of an asset or a liability should always be linked to a past event. He therefore struggled with recognising assets and liabilities from an executory contract, whether as one single asset or liability or as an asset and a liability at the same time.

Commenting on the previous issue of obtaining control, a Board member said that he agreed that the purchaser might control an underlying asset in a forward contract. He asked whether Staff had considered what happened if the purchaser did not control the underlying asset but was economically compelled to buy the asset (for example, a retailer who needed to buy the inventory from a supplier). The Senior Research Manager confirmed that it was considered to some extent and said that the supplier might no longer have control over the asset either, especially if the asset was customised.

Another Board member had a comment regarding the outlined possible approach for measurement. In the Agenda Paper Staff had stated that the IASB might decide that a particular standard should apply the same measurement bases for executory contract assets or liabilities as it specified for the assets and liabilities that arose when one of the parties subsequently performed its obligations and the contract was no longer executory. He asked whether that meant that interest rate swaps could be measured at cost as an interest rate derivative was effectively the delivery of a fixed interest security that could be eligible for cost measurement. The Senior Research Manager said that not every standard needed to follow the suggested approach. The Board member asked whether this meant a departure from the Framework. The Senior Research Manager negated that as the Framework had the overall objective of providing most reliable information.

When asked whether they agreed with the Staff’s recommendation that an enforceable executory contract contained a right and an obligation that constituted a single asset and that a forward contract normally gave the right to buy the underlying resource, not the resource itself, 13 of the 16 Board members agreed. The Senior Research Manager finally asked the Board whether they agreed with the Staff recommendation not to include the measurement of executory contracts in the Conceptual Framework. All Board members agreed.

 

Unit of account

The Director of International Activities seconded from the ASBJ reminded the Board that the IASB’s preliminary view in the Discussion Paper had been that unit of account should be decided at a standards level. Many respondents had agreed with the preliminary view but some respondents had asked for a more detailed discussion of the unit of account.

The Staff recommended that the Board confirmed its preliminary view in the Discussion Paper, i.e. the Framework should describe possible units of account and include a list of factors to consider when determining the unit of account but should not rank the priorities of the factors. The Director then opened the floor for discussion.

One Board member said that the IASB could make explicit in the Framework that there was no single unit of account for all standards and that the unit of account for recognition and measurement might differ in some cases. Also, it could be added that the unit of account would not offset assets and liabilities but was usually either an asset or a liability which could be aggregated for presentation purposes (which would not be a unit of account issue).

A fellow Board member picked up a reference from the Agenda Paper that some respondents wanted the Conceptual Framework to commit the IASB to explain in the Basis of Conclusions to individual standards what unit of account it had selected and why. He asked the staff how they intended to respond to that. The Director said that they agreed with the general idea but did not see the need for requiring it to be in the Conceptual Framework.

The Chairman called a vote on the Staff’s recommendation, all Board members agreed.

 

Presentation and disclosure – communication aspects

The Assistant Technical Manager opened the discussion on presentation and disclosure by highlighting that the Disclosure Initiative was looking into communication aspects of presentation and disclosure as well. Therefore, in the Agenda Paper Staff did primarily look into those principles that were targeted at the IASB. The Staff recommended that the IASB reconfirm the proposals contained in the Discussion Paper, specifically:

  • each standard should have a clear objective for disclosure and presentation requirements;
  • the IASB should develop disclosure and presentation requirements that promoted effective communication of useful financial information; and
  • the communication principles proposed in the Discussion Paper that had been primarily directed at the IASB should be included in the Conceptual Framework and discuss how they related to the qualitative characteristics.

The Assistant Technical Manager asked the IASB whether they agreed with those recommendations.

Whilst supporting the above in principle, the Vice-Chairman flagged his concerns about using the wording ‘entity-specific’. He felt that this was not quite right and should be rectified.

One Board member said that the Board could be more specific by enumerating the range of possible purposes of disclosures, for example: disaggregating or analysing information in the primary financial statements, providing information about assumptions, or explaining how the principles of a standard were applied in a certain case. These purposes could be linked back to the communication aspects.

A fellow Board member asked how the staff planned to proceed with those communication principles in the Discussion Paper for which Staff had identified that they needed to be dealt with on a Conceptual Framework level. The Assistant Technical Manager replied that some of the principles were more targeted towards the preparation of financial statements and should hence be picked up on a standards level. The purpose of the table included in the Agenda Paper was to identify those principles that were targeted more towards the IASB and that should therefore be included in the Conceptual Framework, namely principles that:

  • promote the disclosure of useful information that was entity-specific;
  • result in disclosures that were clear, balanced and understandable;
  • avoid duplication of the same information in different parts of the financial statements; and
  • optimise comparability without compromising the usefulness of the information disclosed.

The Chairman asked the Board whether they agreed with the Staff recommendations. All agreed.

The Assistant Technical Manager said that the next recommendation was to not include a discussion about financial statements in an electronic format in the Conceptual Framework. The Board agreed.

 

Presentation and disclosure – materiality

The Assistant Technical Manager said that this paper was about the concept of materiality in the Conceptual Framework. She highlighted the work stream under the Disclosure Initiative that dealt with materiality as well as the Research Project, which was targeted towards the application of the materiality concept around the world. Staff recommended that no amendments to the concept of materiality in the existing Conceptual Framework be proposed in the Exposure Draft.

One Board member asked what the implications of agreeing were. She asked whether that would mean that the Exposure Draft would be amended as a consequence of the other projects mentioned. The Assistant Technical Manager replied that this would be an unlikely outcome as the projects focussed on the application of materiality rather than the concept as such. The Senior Director for Technical Activities said that U.S. courts had focussed on the word ‘would’ as opposed to ‘could’ when judging about materiality, i.e. misstatements and omissions that ‘would’ (instead of ‘could’) influence the economic decisions of users. The current Framework used the word ‘could’. He said that the research could indicate that ‘could’ was too low a threshold and, therefore, there was a risk that the concept needed to be changed but the analysis would be done in time for the Exposure Draft.

One Board member said that replacing ‘could’ with ‘would’ would be a fundamental reconsideration of the materiality concept. Another Board member agreed and said that it should be discussed in the Framework project. He said that for each standard materiality could differ, hence, there could be no general threshold in the Framework. However, he would appreciate if the reason for that could be included in the Framework. Also, the Framework could say that the Board was not prohibited to set a threshold on a standards level basis.

Another Board member said that the lower threshold served investors better and that this was one of the big advantages of IFRSs. One Board member interjected saying that this was also the cause for disclosure overload.

One Board member disagreed with the remark made by the Board member before who stated that the IASB would be prohibited from setting materiality thresholds on a standards level. He said that this would be possible under the current Framework.

A fellow Board member asked what the word ‘user’ meant in the context of this discussion. Together with the word ‘could’, this set a very low threshold in his view. The Assistant Technical Manager replied that it would be the primary users as defined in the Conceptual Framework. The Board member asked to clarify this in the drafting. Another Board member agreed with that.

The Chairman asked the Board whether they agreed with the staff recommendation if the word ‘users’ would be replaced with ‘primary users’. The Board agreed.

 

Distinction between liabilities and equity

The Technical Manager started this slot by reminding the Board that the distinction between liabilities and equity had last been discussed at the April Board meeting where the Board had discussed the objectives of the distinction and tentatively decided to retain the binary split. He said that this paper would build on that discussion. He pointed out that the session was merely educational in character. The approach taken in the Agenda Paper was to identify user information needs about claims and to provide a background on why information was needed. This would serve as a basis for the development of different approaches on how to distinguish liabilities from equity. The analysis was based on a narrow scope looking into basic instruments only. More complex instruments would be considered at a later stage of the project. The agenda paper also included an analysis of the context of the discussion. Chapter 1 of the existing Conceptual Framework was used as a starting point for the main analysis.

The Technical Manager continued with a slide presentation to illustrate the main analysis in the Agenda Paper (the slide deck is available here). The first two slides illustrated how straight debt and common shares would be presented on the balance sheet and how their servicing would be presented in the income statement. Having demonstrated these basic instruments, the analysis then focused on instruments that, in the past, were known to have created issues in practice, notably share-settled debt (i.e. obligations to deliver a variable number of common shares equal to the value of straight debt) and puttable shares (i.e. obligations to deliver a variable amount of cash equal to the value of common shares).

Slide 4 described a classification approach labelled the ‘settlement approach’ by the Staff. Under this approach puttable shares would be classified as liabilities, as the entity was required to buy back the shares at their fair value and, therefore, a transfer of economic resources would be required to settle the obligation. On the other hand, share-settled debt would be classified as equity as the entity would be required to deliver a variable number of shares to settle a fixed amount. Therefore, this would not encompass a transfer of economic resources. The gain or loss on remeasuring puttable shares would be recognised in the income statement, whilst the return on share-settled debt would be presented in the statement of changes in equity. One Board member asked whether the latter could be seen as interest. The Technical Manager confirmed this.

Slide 5 showed the so-called ‘value approach’. Under this approach, share-settled debt would be classified as a liability, since settlement of the obligation required the transfer of a specified value that was independent of the entity’s economic resources. Puttable shares would be classified as equity as the value of the obligation was dependent on the entity’s assets. The Chairman asked why this was called ‘value approach’. The Technical Manager replied that the settlement approach focused on which economic resources were required to settle the obligation whilst the value approach focused on the driver of the value of the obligation (i.e. whether net assets would drive the value of the obligation). One Board member asked whether the Technical Manager’s remark that an entity could not issue shares beyond its resources also included unrecognised assets (e.g. self-generated goodwill). The Technical Manager confirmed this. He said that going beyond the enterprise value would result in a collapse of the share price.

Slide 6 illustrated a combination of the settlement and value approaches. Under this approach share-settled debt and puttable shares would both be classified as liabilities, as either a transfer of the entity’s resources or a transfer of a specified value independent of the entity’s economic resources would be required to settle the obligation.

Slide 7 depicted the outcome under the narrow equity approach proposed in the Discussion Paper, under which any claim would be classified as a liability if it was not the most residual claim on the entity. Therefore, share-settled debt and puttable shares would be classified as liabilities. Also, certain classes of ownership instruments would be classified as liabilities if they were not the most residual class of capital.

The Technical Manager summarised the Staff’s analysis by saying that the narrow equity approach would probably have more disadvantages than advantages. Also, the settlement and value approaches had advantages and disadvantages and in any case, further information would be required in the financial statements for either approach to provide sufficient information to users. The staff leaned more towards the value approach as it provided comparatively more decision-useful information than the other three approaches. The Technical Manager then turned the subject to the Board for discussion.

One Board member expressed his concerns that under the value approach, share-settled debt would be classified as a liability. He said that newly issued shares would be backed by resources of the entity that were not recognised. He said that he could not see a liability as it was an obligation that would be settled using unrecognised resources. The Technical Manager replied that in this case, any obligation settled in the entity’s own equity instruments would not be a liability. Another Board member asked if the Board member’s view would change if shares were issued to the market and the cash proceeds be used to settle the obligation. The Chairman replied that this would indeed be different as equity would be increased first and then decreased again to settle the obligation. Until it was settled, the obligation remained a liability. The Board member asked whether only skipping the step of increasing and decreasing equity would make the difference in that case. The Chairman believed it would. The Board member then asked why, in that case, anything that could be settled in own shares would be a liability. A fellow Board member replied that it would depend on whether there was an option to settle the obligation with other resources or whether equity settlement was required.

One Board member said that permanence mattered to her when looking at the defining characteristics of equity. This would be close to the Staff’s settlement approach. From a risk perspective, one needed to distinguish between common shares and puttable shares. Further, she did not necessarily insist on the remeasurement of puttable shares going through P&L as long as they were remeasured. She also said that a statement of changes in equity was needed as the balance sheet would not reflect all assets at their current values. On balance, she favoured the combined approach.

Another Board member said that he appreciated the fact that the Staff examined the issue from a balance sheet perspective at the same time as from an income statement point of view, as previous attempts by the Board to deal with the issue had mainly focused on classifying instruments on the balance sheet only. It was only when then considering the impact of such classification on the income statement later on that nasty knock-on effects had become apparent. As he saw it, there were problems with all the approaches presented. As regards the settlement approach, he conceded that it looked strange to have interest on share-settled debt not being presented in P&L. On the value approach, he felt that showing non-permanent items in equity looked strange. The combined approach had the problem of showing gains or losses on puttable shares in performance, thus creating the same problem that the Board had when dealing with the own credit issue. He believed that trying to solve the issue around share-settled debt and puttable instruments by just looking at the balance sheet and the P&L was insufficient; one also needed to look at other means such as OCI, the statement of changes in equity or other alternatives. He felt that there had be another element for the statements so as to allow a split of equity into permanent and non-permanent portions.

One Board member asked whether the settlement approach was in accordance with the fixed-for-fixed criterion in IAS 32. The Technical Manager confirmed this. The Board member asked what would happen if it were fixed-for-variable instead fixed-for-fixed. The Technical Manager said that this would also lead to equity classification under the settlement approach.

Another Board member pointed out that she would rank information on solvency higher than on liquidity, thus preferring the value over the settlement approach. One Board member replied that liquidity was evenly important information as in the past, many entities had become illiquid. Notwithstanding this remark, he would also prefer the value approach or a combined approach over the settlement approach.

One Board member said that for him, equity would imply sharing the risks of an entity. He thought that the value approach would cover this idea best. Also, he said that liquidity information was of short-term interest for the users and solvency was a long-term interest. The Vice-Chairman added that he found the split between liquidity and solvency confusing. The Technical Manager replied that he wanted to suggest two different user assessments. The Vice-Chairman said that the labels ‘liquidity’ and ‘solvency’ might be unsuitable for what the Staff was trying to describe.

One Board member suggested enhancing the illustration in the slide deck with a simple numerical example. Another Board member asked how share-settled debt would influence solvency. The Technical Manager replied that if the obligation was larger than the sum of recognised and unrecognised assets, it would affect solvency. The Board member agreed but also said that this would be the only case and would not be very likely. In other cases it would only restrict the entity’s ability to enter into more obligations, but it would not affect solvency.

Another Board member said that the settlement approach should be further explored. He also said that the dilution effect on equity should be explored.

A fellow Board member said that he would not be able to decide on any of the approaches as all of them had shortcomings. He said that he would like to see a conceptual answer instead of looking at classification of specific instruments. The Technical Manager replied that the intent was to find an approach that solved the most (albeit not all) problems.

A Board member asked whether the fact how an obligation was settled would be important, as even with cash settlement an entity could issue shares and use the cash proceeds to settle the liability. The Technical Manager agreed that it should be examined whether the type of settlement was of significance in liquid markets.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.