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Conceptual framework

Date recorded:

The IASB continued its discussion of the comments received on the Conceptual Framework exposure draft (the ‘CF ED’). The topics for this meeting were as follows:

  • Liability definition and supporting concepts—the ‘no practical ability to avoid’ criterion (AP 10C);
  • Liability definition and supporting concepts—reducing the risk of further changes (AP 10D);
  • Liability definition and supporting concepts—other topics (AP 10E);
  • Effects of the proposed changes to the Conceptual Framework on preparers (AP 10G);

In addition, the tentative decisions made to date were summarised in AP 10A. APs 10B and 10F (discussed in the October 2016 Board meeting and reproduced for reference only) provided background information to support APs 10C–10E.

The Staff intends to discuss the following topics in the December Board meeting: (a) derecognition; (b) measurement; (c) capital maintenance; (d) business activities and long-term investment; (e) the Exposure Draft Updating References to the Conceptual Framework; and (f) the review of potential inconsistencies between existing IFRS Standards and the revised Conceptual Framework.

Conceptual Framework - Liability definition and supporting concepts — the ‘no practical ability to avoid’ criterion - Agenda paper 10C

Background

The CF ED proposes that an entity has a present obligation to transfer an economic resource if (a) the entity has no practical ability to avoid the transfer; and (b) the obligation has arisen from past events. Many respondents broadly agreed with the proposal, except banks. Banks expressed concerns about the implications of the ‘no practical ability to avoid’ criterion in classifying financial instruments as liabilities or as equity. Furthermore, many respondents were concerned about the difficulties in interpreting the ‘no practical ability to avoid’ criterion as they believe this will involve substantial subjectivity. The respondents were also divided in their views as to whether, and to what extent, economic compulsion should be considered in assessing whether a present obligation exists. They cite that there could be particular difficulties in judging whether an action to avoid a transfer ‘would have economic consequences significantly more adverse than the transfer itself’—especially if the consequences were unpredictable and assessments were likely to change over time.

Staff analysis

With regard to the banks’ concerns, the Staff noted that the Board is addressing financial instrument classification in the financial instruments with characteristics of equity project (the ‘FICE project’) and that the Board has decided that the concepts in the revised CF will not necessarily limit the range of possibilities explored in that project.

As regards the difficulties in interpreting the ‘no practical ability to avoid’ criterion, the Staff noted that preparers would rarely be required to apply this criterion without further requirements and guidance. This is because the Board would apply this criterion when it is developing Standards for particular transactions, and it could provide additional guidance to reduce the subjectivity involved in identifying liabilities for those transactions.

As regards the economic compulsion issue, the Staff continued to believe that in some circumstances, the economic consequences of taking an action to avoid a transfer may be so adverse that an entity has no practical ability to take the avoiding action in those circumstances. However, the Staff agreed that assessing the economic consequences of avoiding actions may not always be an appropriate and workable basis for determining whether an entity has the practical ability to avoid a transfer. This is especially the case if the economic consequences of the transfer or the avoiding action (or both) are prone to price fluctuations. The Staff further noted that the factors used to assess whether an entity has the practical ability to avoid a particular transfer should depend on the type of transaction under consideration.

The Staff’s analysis indicated that there is no need to amend the CF ED for other issues raised by the respondents.

Staff recommendation

The Staff recommended refining the ‘no practical ability to avoid’ criterion to state that, in order to conclude that an entity has no practical ability to avoid a transfer:

  • (a) the factors considered should depend on the type of transaction under consideration; and
  • (b) it would not be sufficient that the management of the entity intends to make the transfer or that the transfer is probable.

Discussion

The Board approved all of the Staff’s recommendations.

There was overwhelming support from the Board for the Staff’s proposals. A few members said that the proposed hurdle of ‘if all avoiding actions would have economic consequences significantly more adverse than the transfer itself’ was just the right balance for the liability assessment. Even though two Board members raised specific questions, both of them reiterated that they could live with the Staff’s proposals.

One Board member believed that the term ‘no practical ability to avoid’ should be replaced with ‘no realistic alternative’. His concern centred on cases where there was no binding legal obligation to carry out an action, and cited a lease renewal option as an example, where the contractual terms and economic conditions were such that an entity might have no realistic alternative to renewing the contract (and thus meeting the definition of a liability), but it would have the practical ability to avoid renewing the contract because there was no obligation to renew in the first place. Accordingly, he believed that the term ‘no realistic alternative’ would better depict scenarios where the Board would have expected a liability to be recognised.

Another Board member was concerned that there might be tension between the ‘no practical ability to avoid’ criterion and the position the Board had tentatively reached in the FICE project. She believed that the application of the ‘no practical ability to avoid’ concept might result in an answer that was different from the FICE project. She pointed out further that the proposed CF did not give any concrete guidance to the Board for future standard setting when considering the ‘no practical ability to avoid’ criterion. She also asked whether this concept was applicable to obligations other than those that were legally enforceable. The Staff responded that the concept also covered the likes of constructive obligations, and that the gist of the proposal was to move away from the strict IFRIC 21 notion of when a liability should be recognised.

Conceptual Framework - Liability definition and supporting concepts — reducing the risk of further changes - Agenda paper 10D

Background

This paper considered refinements to the CF ED to reduce the risk of including concepts in the CF that may need to change as a result of future decisions on classifying financial instruments arising from the FICE project.

Staff analysis

The Staff identified the following paragraphs in the CF ED that relate to the classification of claims as a liability or equity:

  • (a) Paragraph 4.33(b) states that if an entity prepares financial statements on a going concern basis, it has the practical ability to avoid a transfer that would be required only on the liquidation of the entity or on the cessation of trading. This statement implies that any present claim that would be settled only on liquidation is an equity claim, which is inconsistent with the approach being developed (Gamma) which classifies an obligation to transfer an amount only on liquidation of the entity as a liability if that amount is independent of the entity’s economic resources.
  • (b) Paragraph 4.30 states that an obligation of an entity to transfer its own equity claims to another party is not an obligation to transfer an economic resource. That statement implies that an obligation for an entity to transfer its own equity instruments never constitutes a liability (even if the obligation requires the transfer of a variable number of equity instruments), which is inconsistent with existing IFRS requirements.
  • (c) Paragraph 4.31 states that an entity has a present obligation to transfer an economic resource if (a) the entity has no practical ability to avoid the transfer; and (b) the obligation has arisen from past events. The Staff notes that the purpose of this paragraph is to help identify when any claim meeting the definition of a liability arises; however, the Staff is concerned that it could be interpreted to mean that any claim that meets these two criteria would be a liability, and could not be an equity claim.

Staff recommendation

The staff recommended amending the CF ED to remove the inconsistencies identified above. The proposed drafting was included in the appendix.

Discussion

All Board members were in favour of the Staff’s recommendation.

One Board member asked about the classification of a hypothetical instrument in the case envisaged by (a) above. This was fielded by another Board member who explained the approached currently under development (Gamma) in the FICE project and how that would apply to the query raised by the first Board member.

Conceptual Framework - Liability definition and supporting concepts — other topics - Agenda paper 10E

Background

This paper considered feedback on the following issues:

  1. The interpretation of ‘as a result of past events’. Respondents noted difficulties in applying the concept that ‘the entity has received the economic benefits, or conducted the activities, that establish the extent of the obligation’ when assessing what is the event that constitutes the ‘past event’.
  2. Is there a need for both ‘present’ and ‘as a result of past events’ in the asset and liability definitions? Respondents suggested omitting either ‘present’ or ‘as a result of past events’ from the definitions of an asset and a liability on grounds that it is redundant—a ‘present’ obligation (or economic resource) is one that is the result of past events.
  3. Introducing the concept of a ‘present claim’ to the liability definition. The CF ED states that the objective of general purpose financial reporting is to provide ‘… information about the entity’s economic resources and the claims against the reporting entity.’ Some respondents are concerned that by merely referring to claims (as opposed to present claims), the proposed ‘no practical ability to avoid’ criterion of the liability definition might be interpreted as encompassing items that are not present claims, e.g. future asset maintenance costs, future salaries and future operating losses.
  4. Correspondence between assets and liabilities. Some respondents questioned whether the concept in paragraphs 4.25 and 4.26 of the CF that if one party has a liability another party has an asset always holds true. They suggested removing this statement from the CF.
  5. Introducing concepts for non-reciprocal transactions. A few respondents suggested that the CF should include concepts that specifically address non-reciprocal transactions such as donations and income taxes.
  6. Concepts on existence uncertainty. Feedback indicates that there is difficulty in concluding whether a liability exists in certain circumstances, and if so, what is the nature of the liability.

Staff recommendation

Issue 1

The Staff recommended that, to clarify the meaning of ‘as a result of past events’ in the definition of a liability, the CF be revised to:

  • (a) refer to an activity of the entity ‘that will or may oblige it to transfer an economic resource that it would not otherwise have had to transfer’, instead of the activity ‘that establishes the extent’ of the entity’s obligation (as was proposed in the ED).
  • (b) clarify that the enactment of a law (or the introduction of some other enforcement mechanism, policy or practice, or the making of a statement) is not in itself sufficient to give an entity a present obligation. The entity must have conducted an activity to which a present law (or other present enforcement mechanism, policy, practice or statement) applies.

Issue 6

The Staff recommended splitting the discussion of existence uncertainty in the CF ED as follows:

  • (a) the discussion of how existence uncertainty arises should be moved to the concepts on identifying assets and liabilities (Chapter 4);
  • (b) the discussion of the consequences of existence uncertainty for recognition should remain in the concepts on recognition (Chapter 5).

The Staff recommended that no change be made for the other issues based on analyses performed, mostly on grounds that the issues have been considered before, only a few respondents raised the issues, or the respondents did not put forward new arguments to challenge the analyses already provided in the Basis for Conclusions.

Discussion

Issue 1

The Board approved the Staff’s recommendation, subject to redrafting paragraph 4.36 such that it would lay the foundation of principles to be applied to transactions rather than trying to address particular fact patterns.

One Board member questioned how the revised wording would apply to rate regulated activities. The Staff responded that that was to be addressed in a separate project.

Two other Board members were concerned that the redrafted words would still lead people to the conclusion that a liability existed now (as opposed to only arising at a future date). Both of them focused on the smoke filter example (agenda paper 10F Example 2.7). They said that the enactment of the law ‘may oblige the entity to transfer an economic resource’ (based on the proposed wording), and this coupled with having ‘no practical ability to avoid’ shutting down the factory would lead to there being a liability. They questioned what the ‘past event’ was – was it having the factory and operating it? Or was it the passing of the new legislation? The Staff responded that having the factory was not the past event. It was the enactment of the law coupled with operating after the specified future date that constituted the past event. At all times, there must be (i) a past event and (ii) no practical ability to avoid a transfer of economic resources for there to be a liability. In the smoke filter example, the Staff agreed that there was no practical ability to avoid either installing the filters or paying the fine, and that would lead to either an exchange or a transfer of economic resources; however, there was still 6 months before the law would take effect. There was no liability in this case, and the focus was on the proposed revised wording of having to transfer an economic resource that it would not otherwise have had to transfer. The entity had done nothing up to the year-end that would oblige it to transfer economic resources that it would not otherwise have had to transfer (be it installing the smoke filters or operating without the smoke filter post 30 June 20X1). The Staff contrasted this with a hypothetical case of where a tax was imposed to all electricity companies just for their being electricity companies without having to do anything else. A present obligation would exist in this case.

Issues 2-5

All Board members agreed with not making any changes in relation to these issues.

Nevertheless, for issue 5, one Board member disagreed with the Staff’s comment that the concepts developed in the CF project were equally suitable for reciprocal exchange transactions and non-reciprocal transactions. He suggested that the concept of non-reciprocal be explored further in the future in order for the Board to cover these transactions properly.

Issue 6

All Board members were in favour of the Staff’s recommendation.

Conceptual Framework - Effects of the proposed changes to the Conceptual Framework on preparers - Agenda paper 10G

Background

The Board published Exposure Draft Updating References to the Conceptual Framework in May 2015 which proposes to replace references to the current Framework in Standards with references to the Conceptual Framework (as revised by the proposed CF ED). As IAS 8.11 requires entities to develop accounting policies by reference to the Framework in certain circumstances, this paper analyses the significance of the changes, if any, that might be required to accounting policies developed by reference to IAS 8.11 as a result of the proposed replacement of references.

The Staff asked the Board for feedback on the analysis performed but did not ask them to make any decisions at this meeting.

Staff analysis

The Staff analysis indicatee that the proposed replacement of references in IAS 8 is likely to have a limited effect on preparers’ existing accounting policies because:

  • (a) it is rare for preparers to develop accounting policies by reference to the Framework; and
  • (b) in some areas the revised concepts will result in outcomes that are similar to the existing concepts.

Discussion

No decision was made at this meeting.

One Board member asked the Staff to emphasise in future outreach activities that the respondents should consider the definition of the elements as well as the principles of recognition and measurement together, as opposed to considering each of them in isolation, as the latter ran the risk of making comments out of context.

Another Board member asked whether, in terms of IAS 8.12, the proposed revised CF would still be considered as being similar to the one under US GAAP. Another Board member reasoned that (i) as the Board had concluded that the proposed CF had not been changed that much and (ii) the fact that the current Framework was considered basically in line with its US GAAP equivalent, one could conclude that the proposed revised CF would still be regarded as similar to the one under US GAAP.

One Board member suggested that, as a separate project, the Staff research further into the interaction between the scope exclusions in each Standard and IAS 8. She noted that if a Standard did not say that a particular type of transaction fell within its scope, it did not mean that that Standard did not apply to the transaction in question. However, from the feedback received, this appeared to be what some respondents were thinking when using IAS 8 to develop accounting policies.

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.