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Financial instruments with characteristics of equity

Date recorded:

Agenda Paper 5A: Relevance of identified features to particular assessments of financial position and financial performance

The Technical Manager opened the session by informing the Board that the agenda paper focused on the assessments users might make. The staff had identified two different types of assessments of financial position (assessments A and B) and two types of assessments of financial performance (assessments X and Y).

The Board was not asked to select or prioritise any assessments at this point. The Technical Manager only asked for a discussion of the assessments.

Assessment A was an assessment of the extent to which the entity was expected to have the economic resources required to meet its obligations as and when they fell due. The main feature relevant to assessment A was the timing of the required settlement. The type and amount of economic resources required were secondary features.

Assessment B was an assessment of the extent to which an entity had sufficient economic resources to satisfy the total claims against the entity at a point in time. The primary feature of this assessment was the amount of resources required. The timing of required settlement was irrelevant. The assessment distinguished between claims that were independent of the availability of the entity’s actual resources and those that were not.

The classification was different depending on which assessment should be satisfied.

One Board member found the approach interesting and suggested to continue on this basis, however he warned that it should not be forgotten what the reason behind this analysis was. Another Board member said that the probability of events occurring needed to be taken into account. This could in turn put emphasis on different relevant features. The Technical Manager agreed and said that, for example, the probability of whether an instrument is settled in cash or in shares was relevant.

Several Board members touched on shares redeemable at fair value. One Board member asked what would happen if the share price went up solely on the basis of internally-generated goodwill. In this case, there would not be enough liquidity for redemption. He agreed with the staff’s conclusion that this would be equity under assessment B as it should not be remeasured. If it were classified as a liability, the remeasurement would increase the liability without a corresponding increase in assets. This could however be addressed by recognition of the remeasurement in OCI.

One Board member referred to the analysis of cumulative preference shares under assessment B, which resulted in a classification as liabilities. She agreed that it was technically an obligation. However this assessment would change if economic compulsion was taken into account. As long as the entity did not go into liquidation, there was no obligation to pay for those instruments. The Technical Manager replied that not just one assessment should be selected. He said that regardless of the classification, information needed to be presented.

A Board member agreed with the staff conclusion that under assessment B claims that specified an amount independent of the availability of the entity’s resources should be liabilities. She said that the question was whether instruments needed to be remeasured or not. The ensuing question was where the remeasurement should go (e.g, P&L, OCI, etc.).

One Board member asked which assessment was more important. The Technical Manager replied that it depended on the circumstances.

The Technical Manager went on to the assessments made on the financial performance.

Assessment X was an assessment of the components of changes in economic resources, other than changes that resulted from issuing claims, or distribution from settling claims.

Assessment Y was a comparison of the returns on the entity’s economic resources to the promised returns of the entity’s claims.

One Board member agreed that shares redeemable at fair value specified a return that was dependent on the actual return on the entity’s economic resources and higher priority claims. She wondered however where the changes in fair value should be recognised as OCI was also a part of performance.

Another Board member urged the staff to focus early in the project on whether adding features to instruments changed their classification in a binary model. He said that this was vital for the project to have more traction.

No further comments were made.

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