Present value measurements — Discount rates

Date recorded:


In this educational session, the staff updated the IASB on their findings regarding the components of present value measurement and measurement methodology.

The staff have identified the following potential financial reporting problems in these areas:

  1. application of an entity-specific perspective in measurement;
  2. inconsistent reflection of liquidity risk; and
  3. three issues relating to the methodology of reflecting tax in measurement.

Application of an entity-specific perspective in measurement

The staff has identified that there is a prevalence of companies not recognising any goodwill impairment even though their book value of equity is higher than their market value of equity. According to staff this could indicate that there is an issue with applying the entity perspective in practice, because value in use is used in goodwill impairment tests.

With regard to that, the staff identified two possible causes:

  1. the principle of entity-perspective measurement as set out in IFRS is sound, but the problems stem from difficulties in implementation, audit and enforcement; or
  2. the principle of entity-perspective measurement as set out in IFRS is flawed.

Inconsistent reflection of liquidity risk

Staff found that liquidity is not consistently reflected in entity-specific current value measurements.

Reflecting liability-specific liquidity would have a material impact on measurement of defined benefit liabilities and provisions.

Not reflecting the liquidity risk can have a material impact on comparability.

Three issues relating to the methodology of reflecting tax in measurement

The staff identified the following three issues regarding measurement methodology for tax:

  • The pre-tax rate should only reflect tax effects that will not be picked up by the application of IAS 12. Market pre-tax rates reflect the market perspective and therefore include some tax. Recognising entity-specific deferred tax on this rate would overstate the tax effect.
  • Users make mistakes when grossing up post-tax rates to arrive at a pre-tax rate.  Furthermore, as the terms ‘pre-tax’ and ‘post-tax’ are not defined, users may think that the pre-tax input does not depend on the rate of tax and therefore use an inappropriate pre-tax rate.
  • IAS 36 adds complexity to the measurement methodology by mandating pre-tax rates. Often, the starting point for the calculation of value-in-use is the post-tax rate that then needs to be converted.

The analysis was being discussed as part of the research project on discount rates and the Board was not being asked to make any technical decisions in this session.

Board discussion

Before getting to the specific financial reporting problems that the staff had identified, several IASB members pointed out that the term ‘financial reporting problem’ was not properly defined. Therefore it would be difficult to determine whether the issues identified by the staff were indeed financial reporting problems and it would also be challenging to determine whether there were any other financial reporting problems that had not been identified by the staff. One Board member said it had to be distinguished between cases where the Standard deliberately allowed diversity in practice and cases where the Standard was clear but the application led to diversity in practice. The former would not be an issue in his view.

Regarding the entity-specific perspective in measurement, several Board members suggested to define the term ‘time value of money’. One Board member suggested that the Conceptual Framework state that the time value of money should always be considered. Another Board member added that the discount rate should consider all possible factors and not only the time value of money. The Senior Technical Manager replied that in general there was no problem with time value of money, as a risk-free rate would be used. She conceded that deriving the risk-free rate could be an issue. Several Board members confirmed that government bonds might not always be the appropriate reference for the risk-free rate. One Board member stressed that the timing and the currency of a government bond should match the item that is valued. A fellow Board member replied that in some jurisdictions government bonds were very risky even though they matched the currency. The government might therefore not always borrow at the lowest rate in those countries. Also, own credit risk might play a role.

The Chairman proposed to develop sound principles for present value measurement techniques which would eliminate the inconsistencies in practice. The Senior Technical Manager confirmed that it should be explored what the measurement objectives for different present value measurement techniques were. However, this should be picked up in the project on the Conceptual Framework.

The Senior Technical Manager noted that the project was mainly about current measurements that are not fair value, e.g. pensions, provisions and value in use. She pointed to the fact that there were many entities with a book value of equity larger than their market value of equity and nevertheless, that did not have accounting impairments. The staff had concluded that this was due to the entity-specific value in use being higher than the market-based fair value. Regulators continued to struggle with “value in use” because as an entity-specific measure it was very difficult to challenge. The problem would not exist in the U.S. as value in use was not permitted by U.S. GAAP. However, the impairment triggers in the U.S. were higher. One Board member warned not to neglect the fact that the U.S. was a very different economy than Europe. The Chairman asked whether this was a general present value issue or solely an issue with value in use. The Vice-Chairman added that in some cases market values do not make sense (e.g. for pensions).

One Board member reminded the meeting that it had been a conscious decision to write off only the non-recoverable part of a book value. The Senior Technical Manager clarified that the staff had no intention of eliminating the value in use; however the issues linked to value in use should be identified and the Board needed to decide whether it was necessary to develop narrower guidance around it. Several Board members asked how the issues with value in use were linked to discount rates. For them it was more a question of measurement objective. The Senior Technical Manager replied that the Board would have to decide which components should be examined. She said that IFRS 13 and IAS 36 included all components, however, they led to different measurements. One Board member added that the Board needed to be explicit about components.

Regarding the inconsistent reflection of liquidity risk, the Senior Technical Manager said that liquidity risk was a fairly new consideration in standard-setting. She said that valuations could analogise to the new insurance Standard once published; however more research needed to be performed. One Board member stressed that liquidity risk would be applied differently to the asset and the liability side. A fellow Board member said that it should be thoroughly examined whether it is possible to include the liquidity risk and how including it would improve financial statements.

The Senior Technical Manager said that other risks would be difficult to assess. The Board would have to decide whether risk adjustments should be part of the measurement. One Board member said that he would not see a need to have a risk adjustment with provisions; however, other liabilities should reflect risks. A fellow Board member said that a risk adjustment should reflect all possible variabilities. One Board member replied that it should also include factors other than variability.

A Board member challenged whether discount rates would be needed in accounting at all. He conceded that they were useful in the market but it should be examined how useful they were in financial statements.

Regarding the tax issues, one Board member doubted that using a pre-tax rate on pre-tax cash flows would result in the same measurement as when post-tax rates and cash flows were used. The Senior Technical Manager replied that she would prepare a numerical example for the next session.

The discussion lasted the two hours allocated.  No decisions were made.  The staff plan to bring other parts of draft discussion paper to the Board in the coming months.  However, the general tone of the meeting was that more work and analysis needs to be incorporated into the discussion paper before the Board will be in a position to consider balloting it for publication.  However, Board members did acknowledge that this is important and necessary research.


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