Overview of the amendments to IFRS 17 (Agenda Paper 2A)

Background

In October 2018, the Board established criteria to evaluate whether any of the concerns and implementation challenges identified after the publication of IFRS 17 justified amendments to the Standard. The Board has been considering individual issues since then.  

In this agenda paper, the staff considers as a whole the amendments to IFRS 17 that the Board has tentatively decided to propose by evaluating each of the proposed amendments against the criteria the Board set in October 2018 and considering the likely effects of the proposed amendments to IFRS 17.

The staff conclude that none of the amendments either unduly disrupts implementation, or where there could be disruption, that the potential disruption is justified given the stakeholder feedback.

The staff also performed a cost-benefit analysis for all amendments and concluded that for each of the amendments the cost of implementing the amendment is justified in light of the benefits the amendment will bring.

Due process steps and permission for balloting (Agenda Paper 2B)

Background

In this session, the staff:

• Asked the Board to confirm its tentative decisions from the November 2018 meeting relating to the mandatory effective date of IFRS 17 and the fixed expiry date for the temporary exemption in IFRS 4 Insurance Contracts from applying IFRS 9 Financial Instruments
• Considered the due process steps undertaken by the Board in completing the narrow-scope project on the amendments to IFRS 17 and asked the Board to confirm that it wishes to proceed with an Exposure Draft (ED) to amend IFRS 17
• Asked if there are any planned dissents at this stage

The comment period will be discussed at the May 2019 Board Meeting after obtaining permission from the Due Process Oversights Committee for a reduced comment period.

Decision

The Board members confirmed unanimously that its tentative decisions relating to the mandatory effective date still stand and that all due process steps have been undertaken in completing the narrow-scope project on the amendments to IFRS 17. The staff have permission to ballot and none of the Board members intends to dissent at this stage.

Sweep Issues (Agenda Paper 2C)

Background

This agenda paper discusses additional stakeholder concerns relating to IFRS 17 (and IFRS 9) which have arisen in the project on the amendments to IFRS 17.

The first issue in the paper is with regard to the effective date of the proposed amendments to IFRS 17, where the staff recommends that the effective date is aligned with that of IFRS 17.

The other issues in the paper are with regard to:

• applying the option to disaggregate insurance finance income or expenses between profit or loss and other comprehensive income (OCI) in the general model and using derivatives to mitigate financial risks (Issue 2)
• applying the option to disaggregate insurance finance income or expenses between profit or loss and OCI in the variable fee approach and applying the risk mitigation option (Issue 3)
• reconciliations related to the liability for remaining coverage and the liability for incurred claims when cash flows are net settled (Issue 4)
• the restatement of comparative information when an entity initially applies IFRS 17 and IFRS 9 at the same time (Issue 5)

With regard to Issue 2, stakeholders are concerned with accounting mismatches that could arise between the effect of financial risks in the measurement of insurance contracts applying the general model and derivatives an entity uses to mitigate those risks, which are measured at fair value through profit or loss (FVPL) applying IFRS 9. The staff analyses that the issue only arises when an entity has chosen to apply this option to a portfolio. While this choice has to be made at a portfolio level an entity can minimise the accounting mismatches described by stakeholders by choosing to include all of the effect of changes in financial risks in profit or loss, where the entity will also recognise changes in the fair value of the derivatives. Given the options available to entities and because the Board already considered this matter when developing IFRS 17, the staff recommend not developing a risk mitigation option for insurance contracts accounted for applying the general model for which an entity chooses to apply the OCI option.

With regard to Issue 3, some stakeholders raised similar concerns to those included in Issue 2 above, noting that if an entity chooses to apply the risk mitigation option and the OCI option it will experience the same accounting mismatches. The staff conclude that the analysis provided with respect to Issue 2 above applies to Issue 3 as well. This is because applying the risk mitigation option results in an outcome similar to applying the general model for the risk that the entity mitigates by using derivatives. Thus, entities have options available to avoid accounting mismatches, depending on which information they regard as most important. Therefore, the staff recommend the Board not undertake any further action in this regard.

With regard to Issue 4, some stakeholders noted that specific settlement agreements between reinsurers (the issuers of reinsurance contracts) and insurers (the holders of reinsurance contracts) often include extensive netting arrangements under which all incoming and outgoing payments between the parties are settled net. Similarly, in some relationships between insurers and brokers/managing agents, the broker/agent performs the contractual cash handling and the premiums and claims are settled net with the insurer for all contracts managed by that broker/agent. Those stakeholders observe that for these types of arrangements specific payments such as premiums and claims cannot be assigned to contracts, and hence to groups of contracts, because cash systems are not linked to accounting systems and therefore providing disclosures that distinguish between the liability for incurred claims and the liability for remaining coverage, will require extensive allocations of cash flows. Those stakeholders suggest that the Board should amend the requirements of IFRS 17 to exclude amounts payable and receivable from the scope of IFRS 17 and include them in the scope of IFRS 9. However, the Board has previously decided that measuring premiums receivable and claims payable separately from insurance contracts would result in internal inconsistencies in IFRS 17. The staff think that these views are still valid and hence no amendment to IFRS 17 is justified.

With regard to Issue 5, a stakeholder says that an entity that initially applies IFRS 17 and IFRS 9 at the same time may wish to restate prior periods to reflect the requirements in IFRS 9. However, in this stakeholder’s view, the requirement in IFRS 9:7.2.1 that prohibits entities from applying IFRS 9 to items that have already been derecognised may deter the entity from restating prior periods. The stakeholder recommends the Board amend IFRS 9 to permit entities to apply IFRS 9 to items that have already been derecognised at the date of initial application of IFRS 9. The staff observe that proposing any changes to IFRS 9, particularly with respect to the transition requirements, may risk unintended consequences. Given that insurers can mitigate some of these concerns by applying IFRS 9 for the first time before they apply IFRS 17 for the first time, the staff think that a change to the requirements of IFRS 9 is not required.

Staff recommendation

The staff recommended that the effective date of the proposed amendments should be aligned with the effective date of IFRS 17, so that entities would be required to apply IFRS 17, and any proposed amendments, for annual periods beginning on or after 1 January 2022. Entities would be permitted to apply IFRS 17, together with any proposed amendments, for earlier periods.

The staff recommended to retain the requirements in IFRS 17 (and IFRS 9) with regard to Issues 2 to 5.

Discussion

On Issue 1, one Board member asked if there were any early adopters of IFRS 17 and what the transition requirements were for transition from IFRS 17 (2017) to IFRS 17 as amended. The staff replied that outreach had not produced any evidence of early adopters, so transition requirements are not necessary at this point. Should the IASB learn of any early adopters, the staff would have to think about the transition requirements.

On Issue 2, a Board member said that no further variability should be introduced at this point.

On Issue 5, the Vice-Chair said that this was not a new request and expressed concern that opening up IFRS 9 transition requirements might have many unintended consequences, given the complexity of the Standard. One Board member requested that the Basis for Conclusions of the amendment should include an explanation of the issue and the rationale as to why the Board decided not to proceed with the amendment.

Decision

The Board members voted unanimously in favour of the staff recommendations for all five issues.

Annual Improvements (Agenda Papers 2D & 2E)

Background

In June 2018, the Board tentatively decided to propose minor changes to IFRS 17 for some such instances. At the time, the staff planned to make the changes as part of the Board’s next Annual Improvements to IFRS Standards Cycle. However, because the Board has now also tentatively decided to issue an ED proposing other changes to IFRS 17, the staff plan to include the minor changes in that ED. Since June 2018, through the ongoing implementation activities on IFRS 17, the staff have become aware of a number of other minor changes that would fall within the scope of the annual improvements process.

Some of the topics were discussed at the April 2019 meeting of the IFRS 17 Transition Resource Group (TRG). Agenda Paper 2E summarises the TRG feedback on those issues.

Staff recommendation

Although the changes could be made within the scope of the annual improvement process, the staff recommend to address these changes in the ED of proposed amendments to IFRS 17. Those changes are:

1. Amendment to IFRS 17:B96(c) to exclude from the adjustment to the contractual service margin (CSM) changes between expected and actual repayment of investment component arising due to changes relating to the time value of money and financial risk
2. Amendment to IFRS 17:B96(d) when an entity choses to disaggregate changes in the risk adjustment for non-financial risk between those relating to non-financial risk and those relating to financial risk and the effect of the time value of money. While not required, if an entity choses to make such disaggregation, the change in the CSM due to changes in the risk adjustment relating to future service must be calculated using the locked-in discount rates, as specified in IFRS 17:B72(c)
3. Amendment to clarify that an entity can discontinue the use of the risk mitigation option to a group of insurance contracts only if any of the eligibility criteria for the group in IFRS 17:B116 cease to apply
4. Amendment to clarify the definition of an investment component to be repayable in all circumstances
5. Amendment to ensure IFRS 17 applies to investment components that, if separated, would meet the definition of investment contracts with discretionary participation features
6. Amendments to IFRS 17:48(a) and IFRS 17:50(b) clarifying to adjust the loss component for changes in the risk adjustment for non-financial risk
7. Amendment to clarify that changes in the measurement of a group of insurance contracts caused by changes in underlying items should, for the purposes of IFRS 17, be treated as changes in investments and hence as changes related to the time value of money or assumptions that relate to financial risk

As regards the annual improvement tentatively agreed by the Board in June 2018, the staff confirmed that no amendments to the proposed changes are necessary. 

Discussion

On Amendments 1 & 2 above, a Board member said that the general model should be applied as it stands and if the relief not to disaggregate is elected, then there will be a measurement difference. That difference is acceptable given what the Board intended when providing the relief.

On Amendment 4, the staff acknowledged that they would have to rethink a disclosure requirement in IFRS 17, given the TRG feedback that insurers would have to distinguish premium refunds from investment components only because of the requirement to disclose investment components separately. The reworded disclosure requirement would be brought back to the May 2019 Board meeting as a sweep issue.

Some Board members pointed out that there were at least two different readings of the definition of investment components amongst TRG members. The amendment is therefore very helpful to ensure the consistent application of the Standard. The Board’s intended outcome would not be changed by the amendment, as the Basis for Conclusions to IFRS 17 already includes the words ‘in all circumstances’. The amendment is merely copying those words into the Standard, to make them a mandatory requirement. A solid definition of an investment component has become even more important when the Board tentatively decided in the January 2019 meeting that part of the CSM would also have to be allocated to investment return services.

On Amendment 7, one Board member asked the staff to confirm that the intention was not to change the scope of underlying items. The staff confirmed that was the case and emphasised that this was true for any kind of insurance contract, regardless of whether they meet the criteria for the VFA approach or not. The Standard is clear that underlying items can be any (sub-)set of assets.

Decision

The Board members voted unanimously in favour of the staff recommendations for all seven amendments.

Background

The Board is examining how companies should account for combinations of businesses under common control (“BCUCC”) which are currently outside the scope of IFRS 3 Business Combinations. The staff are working towards publishing a discussion paper in the first half of 2020.

In June 2018, the Board directed the staff to develop an approach based on the acquisition method set out in IFRS 3 to account for BCUCC and to consider whether and how that method should be modified to provide the most useful information about BUCC transactions that affect non-controlling interest (NCI) in the receiving entity (transactions that affect NCI). In December 2018, the Board discussed whether a current value approach based on the acquisition method should be applied to all transactions that affect NCI or only some transactions that affect NCI.

In March 2019, the Board discussed an overview of the staff’s approach and whether a form of predecessor approach could be applied for transactions between wholly owned entities and a current value approach to at least some transactions that affect NCI. The meeting was educational.

Update on the staff’s approach (Agenda Paper 23A)

The BCUCC project focuses on the information about the transaction provided in the receiving entity’s financial statements. The project does not consider accounting by the controlling party, the transferor or the transferee as those parties are already covered by existing IFRS Standards.

In developing measurement approaches, the staff consider the information needs of different types of primary users, the relative complexity of each approach, their costs and benefits, and the structuring opportunities that could arise.

The staff explore using a current value approach to some but not all transactions that affect NCI, for example, when equity instruments of the receiving entity are traded in a public market.

The staff consider separately transactions between wholly owned entities, included transactions that affect lenders and other creditors in the receiving entity, and transactions undertaken in preparation for a sale of the combining entities (e.g. an IPO). For those, the staff explore a form of predecessor approach.

The paper also summarises the input on the staff’s approach received to date, including the March 2019 Capital Markets Advisory Committee (CMAC) and Emerging Economies Group (EEG) meetings. Most interested parties, but not all, supported the staff’s approach.

The staff ask the Board to approve the staff’s approach.

Update on lenders and other creditors in BCUCC (Agenda Paper 23B)

The staff think that the result of the analysis of an entity’s ability to service and raise debt carried out by debt investors and credit analysts would not depend greatly on whether a current value approach or a form of predecessor approach is applied to account for the BCUCC. This is because credit analysis mainly focuses on two areas which are largely unaffected by the use of either method, namely cash flows and nominal amounts and qualitative characteristics of the entity’s total gross debt, including unrecognised commitments and contingent liabilities.

This conclusion was generally supported at the March 2019 CMAC and EEG meetings.

Lenders and other creditors in BCUCC (Agenda Paper 23C)

This paper was discussed at the March 2019 IASB meeting and is reissued for the April 2019 IASB meeting for information. Our summary of the March paper can be found on https://www.iasplus.com/en/meeting-notes/iasb/2019/march/bcucc (Agenda Paper 23B)

The staff recommend that the Board not pursue a single approach that would apply both to:

• transactions that affect NCI; and
• transactions that affect lenders and other creditors in the receiving entity but do not affect NCI.

Board discussion

Board members generally agreed with the direction taken by the staff.

Several comments were made in relation to the staff’s aim to minimise structuring opportunities when developing measurement approaches:

• The focus should be on minimising accounting arbitrage and opportunities rather than corporate structuring as such. Although the Board should be conscious of such opportunities, the aim is not to discuss the validity of such transactions, but rather to reflect their economic consequences.
• Because entities currently use a variety of methods to account for BCUCCs, there is already a risk to use a specific method in order to achieve a particular accounting outcome.
• The staff clarified that the risk of structuring would not arise from not applying the requirements of IFRS 3 to all BCUCCs, but rather from drawing a line between some transactions to which those requirements would be applied, and some transactions that would apply another approach.

The Board also discussed which primary users of the financial statements should be considered when assessing the usefulness of the various measurement approaches. A distinction was drawn between prospective equity investors and existing minority shareholders (which covers both external shareholders in subsidiaries of the receiving entity as well as shareholders who are not part of the controlling party of the receiving entity).  One member noted that the needs of the former in an IPO are taken care of by extensive underwriting and due diligence processes and therefore do not need to be taken into account when preparing primary financial statements.

Several Board members raised the need for additional research on the needs of the users of the financial statements, such as equity investors.

Although most Board members agreed that two different measurement basis should be pursued as part of the project, the Board also noted that the use of a single approach should not be ruled out. Some members also noted that further information was required on what a predecessor method would entail before making a final decision.

Some Board members thought that the starting point should be to apply the acquisition method in IFRS 3. If a different approach is selected, this should be made based on a cost-benefit analysis, i.e. considering whether there are categories of users whose information needs can be satisfied by a simpler, less costly method.

Additional disclosures supplementing a predecessor approach should also be considered, for example, a one-off requirement for fair value disclosures.

If the acquisition method is selected for some or all BUCCs, the Board would also need to consider whether this method needs to be modified in situations where the transaction price is not reflective of fair value. The objective will be to ensure the equity transaction resulting from the BUCC is accounted for. 

One Board member preferred to pursue a single approach for all BCUCCs as a priority. If a decision was made to apply two distinct approaches, there should be a strong conceptual basis to do so, considering the factors highlighted in the Conceptual Framework for selecting a measurement basis.

Board decisions

All Board members agreed that the staff should continue developing measurement approaches for transactions within the scope of the project by considering:

1. whether and how transactions within the scope of the project can be different from business combinations that are not under common control;
2. what information would be useful to various primary users of the receiving entity’s financial statements;
3. whether the benefits of providing particular information would justify the costs of providing that information; and
4. complexity and structuring opportunities that could arise under various approaches.

The Board tentatively decided that it need not pursue a single measurement approach for all transactions within the scope of the project (13 in favour). 

Background

The requirements in IFRS Standards, in particular in IAS 8, make a distinction between how an entity should present and disclose different types of accounting changes in its financial statements. Changes in accounting policies must be applied retrospectively while changes in accounting estimates are accounted for prospectively.

Preparers sometimes struggle to distinguish between accounting policies and accounting estimates and enforcers have identified divergent practices. In September 2017, the Board published an Exposure Draft (ED) to provide some clarification in that area. Since then, a number of matters have been identified through feedback. In this paper, the staff summarises and analyses these views, as well as providing amendments to the proposals in the ED.

Analysis of feedback—Definition of accounting estimates (Agenda Paper 26B)

This paper is split between the key views and the analysis of those views, and the analysis of other matters.

Preliminary views included concerns about:

• a) The role of judgements and assumptions:

Respondents said that estimates are not judgements or assumptions, but rather the numerical output of a measurement technique that requires judgement and assumptions. Defining estimates as monetary amounts would be more consistent with the wording of IAS 37 Provisions, Contingent Liabilities and Contingent Assets and ISA 540 Auditing Accounting Estimates and Related Disclosures. The staff noted it would also be consistent with the use of the term estimate within IAS 8:32 and IAS 36:30(a). The staff recommend revision to the definition of accounting estimates.

• b) Use of terms “estimation uncertainty”, and “precision”:

Some respondents thought the use of “estimation uncertainty” would lead to the definition being circular. Staff agree, and note that the terms “estimation uncertainty” and “precision” are not defined in IFRS Standards. As such, the staff suggest an amendment to use the term “measurement uncertainty”, which is defined in paragraph 2.19 of the Conceptual Framework.

• c) Deleting the definition of “change in accounting estimate”:

Some respondents note that the “change in accounting estimate” paragraph was helpful in distinguishing between changes in estimate and errors, and so requested this should not be deleted (as is currently proposed in the ED). The staff’s basis for the deletion was that IAS 8:34 is similar to the deleted section. The staff note that the wording is slightly different and conclude that practical application could differ. As such, a number of small amendments (see below) have been suggested.

• d) Limiting the definition of accounting estimates to measurement:

Some respondents noted that it was not clear why the proposed definition of accounting estimates focuses only on measurement, when an entity may also use estimates in other aspects, such as determining whether to recognise an item (e.g. recognition of a liability under IAS 37). The staff acknowledge that an entity uses estimates in other situations, but note that the definition of accounting estimates should focus on measurement, as other areas of IAS 8 specify how an entity accounts for changes in amounts reported in the financial statements, resulting from a change in accounting estimates.

Staff recommendation

Staff recommend that the Board:

• a) Revise the definition of accounting estimates to specify that:
  • i. Accounting estimates are monetary amounts in the financial statements that are subject to measurement uncertainty;
  • ii. These monetary amounts are outputs of measurement techniques used in applying accounting policies; and
  • iii. An entity uses judgements and assumptions in selecting and applying the applicable measurement techniques.
• b) Clarify that the effects of a change in an input and/or measurement technique used to develop an accounting estimate are part of the change in accounting estimate and not the correction of an error if that change results from new information or new developments.
• c) Specify that estimation techniques and valuation techniques are examples of measurement techniques an entity uses to develop an accounting estimate.

Discussion

The Board generally agreed with the analysis and the direction of the project. One Board member supported the use of the term monetary amounts when defining an estimate.

Another Board member said that the wording around practical expedients allowed under several other Standards (such as IFRS 16 Leases) is currently unclear, and it should be clarified that these are valuation techniques in making an accounting estimates. The broader point is that calculation of estimates include both complex and simple techniques.

A Board member indicated that they agree with the suggestion that examples of applying the amended guidance in practice should also be included with the amendments. Another Board member noted that the clarification that an estimate is the output of a calculation is helpful to users. They also noted that some information contained in the proposed amendments for which deletion has been suggested, should be extracted and retained. They thought that the notion of a change in estimate being due to a change in information available should be made explicitly clear, as this is an area which causes confusion for regulators.

Analysis of feedback—Other aspects (Agenda Paper 26C)

This paper sets out other views, not in relation to the proposed changes to the definition of accounting estimates. Views and analysis were provided by staff, on the following areas:

• a) Removing the terms “conventions” and “rules” and replacing the term “bases” with “measurement bases”:

Many respondents agreed with the proposed amendments, which would remove the terms “conventions” and “rules”, however a number of respondents questioned if this would improve the definition given the remaining terms are not defined either, and so are open to interpretation. The staff had subsequently suggested amended wording to enhance clarity. However, the Board did not intend to narrow or broaden the scope or nature of accounting policies and suggested that, given the number of respondents with differing opinions, the suggested amendments are removed.

• b) Suggested clarification that selection of first-in-first-out or weighted average cost formula in IAS 2 Inventories is a choice of accounting policy, not an estimate:

A number of respondents felt that this did not align with the proposed definition of accounting policy and accounting estimate, as the selection of a cost formula requires the use of judgements and assumptions, and that the methods allow for an estimation of cash flows related to inventories. Some respondents also noted that inclusion of a specific “rule” in this area would go against the IAS 8 principals-based approach. Given IAS 2:36(a) already states that selecting a cost formula constitutes an accounting policy choice, staff recommend that the proposal to include a specific point on this should be removed.

• c) Proposal to remove IE3 from the Guidance on Implementing IAS 8:
  • i. Several respondents suggest that IE3 is updated as opposed to deleted, as the implementation examples are helpful in determining situations which represent changes in estimates or changes in policy. However, the staff do not propose updating IE3 as in doing so the example would become either too obvious to be of use or too complex, and difficult to draft.
  • ii. A number of respondents agree with the removal of IE3, but note that new illustrative examples would help entities to apply the amendments. This view was confirmed in feedback from the Accounting Standards Advisory Forum and the Interpretations Committee members. The staff therefore suggest that illustrative examples should be added and suggest one such example for comment by the Board.

Staff recommendation

Based on the analysis, staff recommend that the Board should:

• a) Not amend the definition of accounting policies (i.e. retain the existing definition of accounting policies in IAS 8);
• b) Not add any discussion of whether selecting an inventory cost formula constitutes selecting an accounting policy (thus not adding the material proposed in paragraph 32B of the ED);
• c) Confirm the deletion of IE3 in the Guidance on Implementing IAS 8; and
• d) Develop some examples to illustrate the application of the definition of accounting estimates.

Discussion

A Board member suggested adding some words to the accounting policies definition. This is to make clear that if an entity can classify something as an accounting estimate, it cannot be an accounting policy. This proposal is to ensure that there is no confusion over the definitions and the terminology used.

A minority of Board members disagreed with the staff recommendation and thought that the originally proposed amendments to the definition of accounting policies should be finalised. This was on the basis that similar to the proposed changes to accounting estimates, any clarification to such a fundamental area as accounting policies is helpful for users of the Standards, as it leads to time and financial savings. It would become easier to determine if items are changes in policy or estimates, or if they are error.

Project Direction (Agenda Paper 26D)

Background

Agenda Paper 26D discusses the project direction in the light of the feedback on the Exposure Draft. The staff think that, on balance, the expected benefits of proceeding with the proposed amendments outweigh the costs. However, they also acknowledge that the amendments will not address all identified application questions. If the Board concludes that the expected benefits would not outweigh the costs the staff think the Board should stop the project and not proceed with any amendments. 

Discussion

The majority of members noted that any clarification of such fundamental principles as accounting estimates, which affect many balances reported, provides valuable benefits to preparers, users and regulators. It is therefore worth the costs of implementation.

Decision

As in this session, the staff was only seeking comments on their preliminary views, no decisions have been made.

Implementation Matters - IFRIC Update (Agenda Paper 12A & 12B)

Background

The purpose of this meeting wass to provide the Board with an update on recent IFRS Interpretations Committee meetings. No decisions were asked from the Board.

Discussion

As regards “IFRS 9 Financial Instruments—Physical Settlement of Contracts to Buy or Sell a Non-financial Item (Agenda Paper 11 at the March 2019 IFRS Interpretations Committee meeting)” one Board member noted that the conclusion in the agenda decision is correct, however the overall outcome was not desirable. At the date of the transaction, which is a simple delivery of goods, recognising revenue on the receipt of cash applying IFRS 15 Revenue from Contracts with Customers might provide more useful information compared to applying IFRS 9, as stated in the agenda decision.

One Board member said that when IFRS Standards are unclear and this leads to an accounting policy choice, the Interpretations Committee should remain silent on what is the best choice.

Proposed amendments to IAS 1 and IFRS Practice Statement 2: due process steps and permission to begin the balloting process (Agenda Paper 11A)

Background

In response to the 2017 Disclosure Initiative—Principles of Disclosure Discussion Paper (DP), respondents supported the Board in developing guidance about which accounting policies to disclose. Most respondents thought that any guidance developed by the Board should be based on the relevance, usefulness and/or materiality of accounting policies.

Consequently, in its July 2018 meeting, the Board tentatively decided to develop additional guidance and examples for the IFRS Practice Statement 2 Making Materiality Judgements. These would explain and demonstrate the application of the four-step materiality process to accounting policy disclosure.

In its December 2018 meeting, the Board tentatively decided to amend IAS 1 Presentation of Financial Statements to require entities to disclose their material accounting policies rather than their significant accounting policies.

The purpose of this meeting was for the Board to decide whether the staff can begin the balloting process on the proposed amendments to IAS 1 and IFRS Practice Statement 2.

The Board was asked whether they agree:

• a) to permit early application of the proposed amendments
• b) that the proposed amendments should be applied prospectively
• c) to allow 120 days for comment on the Exposure Draft
• d) to begin the balloting process

They were also asked whether any members of the Board plan to dissent from issuing the Exposure Draft.

Discussion

There was not much discussion on this paper. One Board member suggested not to require an entity to make a disclosure if they early apply the amendment.

Decision

All Board members agreed unanimously with points (a) to (d) above.

Research Update - Agenda Paper 8

Background

The staff gave a brief update on the research programme since the last update, provided in the Board’s meeting in December 2018.

The main updates are with regard to the following:

• The Board published project summaries for the research projects on Discount Rates and Disclosure Initiative—Principles of Disclosure and a project report and feedback summary on the post-implementation review (PIR) of IFRS 13 Fair Value Measurement
• The Board moved the project on IBOR Reform and the Effects on Financial Reporting from the research programme to the maintenance programme
• The project on Subsidiaries that are SMEs became active in March 2019.
• The project on Pension Benefits that Depend on Asset Returns has become dormant and is expected to restart in Q3 of 2019.
• The staff expect to start work on the PIR of IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements and IFRS 12 Disclosure of Interests in Other Entities in Q2 of 2019.
• The staff also expect to start work on the pipeline project on the Equity Method in Q2 or Q3 of 2019 because there is some overlap with some of the issues that will be considered in the PIR of IFRS 11.

The Board was not asked to make any decisions in this session.

Discussion

One Board member asked if there is any update on the staff’s intention to conduct the PIR of IFRS 10 to 12 in phases. The staff responded that there is no update.

One Board member asked if the staff have an estimate as to when Business Combinations under Common Control would be moved to the standard-setting agenda. The staff responded that at the moment a Discussion Paper would be likely as the next step, which means it would stay in the research phase until after the Discussion Paper has been exposed.

Oral update

The staff provided the Board with an oral update of the project and a summary of the input received from their meeting with the Management Commentary Consultative Group in early April.

Members of the consultative group agreed that staff has correctly identified the challenges the project needs to address and agrees with the direction of their proposed approach.        

Staff highlighted a few key messages that emerged from the group meeting, including: emphasis on value creation, discussion of opportunities in addition to risks, coherence of messaging, enhanced prominence of ESG (Environmental, Social and Governance) issues, dealing with commercially sensitive information and the effective use of cross-referencing both within a single filing and to other reports and sources of information.

Staff reiterated that their objective was to provide guidance of what should be included within management commentary rather than to mandate the structure thereof.

Staff intends to bring papers to the Board for discussion at their May 2019 meeting.

Discussion

Based on these updates, one Board member asked whether the discussions with the consultative group around cross-referencing had been useful for the staff. Staff responded by saying that the discussions had re-emphasised that management commentary should include only relevant and material information but that cross-referencing to other sources could be effective in some instances to support the information provided.

Finally, the Board raised a concern regarding the conciseness of management commentary based on the number of items considered to be important by the consultative group.

Amending proposals for management performance (Agenda Paper 21A)

Background

This paper discusses the need for amendments to the Board’s proposal on management performance measures (MPMs) in light of feedback received on the proposal and tentative decisions made since the last discussions held by the Board.

Staff analysis

The regulators have expressed concerns that MPMs may not be comparable between entities and may give undue legitimacy and prominence to a non-IFRS measure. Furthermore, the regulators believe that auditing MPMs may be challenging and in the absence of specific constraints on MPMs could lead to entities disclosing some misleading MPMs. The staff do not think that this should prevent entities from including MPMs in the financial statements because the fundamental characteristics of financial statements are relevance and faithful representation and an MPM is a measure that complements IFRS-specified subtotals, which are comparable. The staff do not believe that undue legitimacy and prominence will be given to MPMs because the proposal clearly requires the entity to disclose the fact that management defines the measures. The staff acknowledge that the audit work may be restricted to checking that the MPM has been calculated in accordance with the entity’s definitions of the measure and the entity has complied with the disclosure requirements for MPMs. However, the staff said that this should not deter the presentation of MPMs. The staff have considered, but decided against, introducing constraints for MPMs because “misleading” is not a defined term. Furthermore, some regulators have already defined “misleading” and introducing constraints will result in diversity in practise across different jurisdictions. The staff recommend that the MPMs should be aligned with public communication outside the financial statements to users because it avoids the risk of entities providing two sets of performance measures and it is consistent with the Board’s definition of MPMs. The staff believe it would be useful for entities to identify any income or expenses excluded from MPMs that meet the definition of unusual items. However, the staff note that the principle of disaggregation would need to be applied in determining which income or expense should be excluded from MPMs.

Staff recommendations

The staff recommend that the Board clarify that MPMs are subject to the general requirement that information included in the financial statements must provide a faithful representation. The staff further recommended that the Board make no specific statement that MPMs should not be misleading and do not place specific constraints on how MPMs should be calculated. Lastly, the staff recommend that entities can only identify a measure as an MPM if they use the same measure in their public communications with users outside the financial statements and entities should identify any income or expenses that meet the definition of unusual items that are excluded from the entity’s MPMs.

Board discussion

The Board agree that it is useful to provide a reconciliation of MPMs to GAAP measures and to link this to faithful representation. Some Board members expressed concerns that MPMs is a measure that tend to be biased and there is a risk that by presenting partial information, this would not correctly depict the financial performance of the entity. Therefore, the Board recommended to narrow the application of faithful representation to the labelling of the MPMs. The staff disagrees with this and said that most required subtotals in the statement of financial performance are already a partial measure of an entity’s financial performance but collectively, present the whole picture. The staff agreed to clarify that faithful representation means that the measures the entities provide should represent financial performance of the entity to the users of the financial statements and to clarify that there will be no additional constraints placed on how MPMs should be calculated. The Board also expressed concerns that an unsophisticated user of the financial statement could misinterpret MPMs as an IFRS compliant measure. However, the staff said that the definition of MPMs is consistent with IAS 1 Presentation of Financial Statements, in that the preparer could provide additional information if they believe it would be useful. Furthermore, reconciliations to GAAP measures will be required for MPMs presented, which will mitigate the risk.

The Board recommended that an entity only be permitted to identify a measure as an MPM if they use the same measure in their public communication and after this has been approved by their regulators.

Furthermore, the Board believe that a good reconciliation of MPM should already explain any unusual items included as part of the measure and propose not to explicitly include this as a requirement.

Board decision

12 Board members agreed that MPMs are subject to the general requirement that information included in the financial statements must provide a faithful representation. 11 Board members voted in favour that no specific statement that MPMs should not be misleading and 13 Board members agreed to not place any specific constraints on how MPMs should be calculated. All Board members agreed that entities be permitted to identify a measure as an MPM only if they use the same measure in their public communications with users outside the financial statements. However, only 4 Board members agreed that entities should identify any income or expenses that meet the definition of unusual items that are excluded from the entity’s MPMs.

Outstanding issues for financial entities (Agenda Paper 21B)

Background

This paper addresses the outstanding issues relating to the proposals for financial entities.

Staff analysis

Some entities hold cash and cash equivalents for operational reasons and not as part of their capital structure. Therefore, the Board’s February 2019 tentative decision (after which most entities are required to

present income from cash and cash equivalents below the ‘profit before financing and income tax’ subtotal), would result in the presentation of an “operating profit” subtotal that would not reflect the entity’s result from operating activities. The staff recommend modifying the existing principle to capture the financial entities as intended by the Board. The proposed change is to update the existing principle from “entities that, in the course of their business activities, invest in assets that generate a return individually and largely independent of other entity resources” to “entities that, in the course of their business activities, invest in financial assets that generate a return individually and largely independent of other entity resources.”

Some Board members expressed concern that the tentative decision in February 2019 would not result in useful information for investment contracts with participation features accounted for in accordance with IFRS 9 Financial Instruments. The staff have considered two approaches to address this issue, including introducing a principle that “expenses related to financing from customers should be included in operating profit” or introducing an exception, that “an entity is required to include in operating profit expenses related to liabilities arising from investment contracts with participation features it issues that are in the scope of IFRS 9.” The staff believe that the second approach (i.e. an exception) is preferable because it is targeted to specific contracts, will not disrupt the Board’s model for the statement(s) of financial performance for non-financial entities, uses existing concepts in IFRS 17 Insurance Contracts and is consistent with that of the Board’s intentions.

The staff do not recommend that the Board define “main business activities” but rather to provide guidance to help entities assess whether they meet the definitions of provide financing to customers as a main business activity and whether they invest in the course of its main business activities in assets that generate returns individually and largely independent of other entity resource.

Staff recommendations

The staff recommend that the Board require entities to include income from cash and cash equivalents in operating profit if the entities invest in financial assets that generate a return individually and largely independent of other entity resources, in the course of their main business activities. The staff further recommended the Board require entities to include in operating profit expenses related to liabilities arising from investment contracts with participation features they issue that are in the scope of IFRS 9 and clarify the entities which the Board is referring to when discussing “main business activities”. The staff also recommend that the Board specify that when a business activity constitutes a separate reportable segment applying IFRS 8 Operating Segments, this might indicate that the activity is a main business activity.  And lastly, clarify that income, expense and dividend cash flows from associates and joint ventures not accounted for using the equity method must be classified in the same way as income, expense and dividend cash flows from other investments.

Board discussions

A Board member highlighted that the approval of this proposal is subject to successfully defining “a main business activity.” The Board agree that guidance should be provided on what “a main business activity” means and in particular, for entities with multiple business activities.

Board decision

13 Board members agreed to require entities to include income from cash and cash equivalents in operating profit if the entities invest in financial assets that generate a return individually and largely independent of other entity resources, in the course of their main business activities. 13 Board members agreed to require entities to include in operating profit expenses related to liabilities arising from investment contracts with participation features they issue that are in the scope of IFRS 9. All Board members agreed to clarify what the is meant by “main business activities” and to specify that when a business activity constitutes a separate reportable segment applying IFRS 8 Operating Segments that this might indicate that the activity is a main business activity.  All Board members agreed to clarify that income, expense and dividend cash flows from associates and joint ventures not accounted for using the equity method must be classified in the same way as income, expense and dividend cash flows from other investments.

Understanding how the ideas explored interconnect (Agenda Paper 18A)

Background

In July 2018, the Board tentatively decided that the staff should explore whether:

• Disclosures with regard to business combinations could be improved to assess more effectively whether a business combination was a good investment decision and whether the business is performing as expected
• The accounting for goodwill could be simplified by reintroducing amortisation and/or no longer require annual quantitative impairment testing of goodwill
• The calculation of value in use could be improved by including cash flows that result from a restructuring and by no longer requiring pre-tax inputs in the calculation

In the agenda paper, the staff assesses which objectives (better information, reduction of costs, improving effectiveness) are helped by the ideas, what other benefits are and which objectives are hindered by the idea.

The Board is not asked to make a decision with regard to this paper.

Discussion

One Board member said that the focus should still be on the ‘too little, too late’ (impairment) issue as this seems not to be one of the main objectives in the agenda papers. Another Board member emphasised that a reintroduction of amortisation would not remove the impairment requirements. As with any other intangible asset it would be impairment in addition to amortisation.

Better disclosures for business combinations (Agenda Paper 18B)

Background

In this paper, the staff explores the first bullet from Agenda Paper 18A (see above).

The Board tentatively decided that the staff should explore whether the Board can improve disclosures with regard to business combinations. The post-implementation review (PIR) for IFRS 3 Business Combinations revealed mixed feedback in that regard. Users appear to be particularly interested in understanding the key drivers that determined the amount of consideration and whether the acquisition has subsequently been successful.

Based on feedback from the PIR and from stakeholder outreach conducted (summarised in Agenda Paper 18C), the staff suggest the Board propose two changes to the disclosure objectives of IFRS 3:

Firstly, make the disclosure objectives more specific, to help preparers understand why the information is needed, and thereby help to improve the information produced and secondly, add a new disclosure objective for entities to provide information that users need about the subsequent performance of the acquired business, or combined business.

In the paper, the staff analyse how to improve the disclosure objectives in detail and which additional disclosures would be helpful to better understand the key objectives of a business combination.

Staff recommendation

The staff recommend that the Board add the following disclosure objectives to the existing disclosure objectives of IFRS 3 to provide users with information:

• To evaluate the strategic rationale for the business combination
• To understand the amount of, and evaluate the rationale for, the total consideration transferred to obtain control of the acquiree
• To evaluate the extent to which the key objectives of the business combinations have been achieved.

The staff also recommend that IFRS 3:B64(d) be amended to require an entity to disclose:

• The strategic rationale for undertaking the business combination, such as how the acquisition links to the acquirer’s business strategy
• The key objectives of the business combination, being the targets management expect to achieve as a result of undertaking the business combination

An acquirer should also be required to disclose, in the reporting period when a business combination occurs:

• what measures the Chief Operating Decision Maker (CODM) plans to use, in future internal reporting, to assess the extent to which the key objectives of the business combination have been achieved
• the amounts of those measures being used to assess the extent to which the key objectives of the business combination have been achieved (this information would also be required for at least the next two annual reporting periods)

An acquirer should be also required to disclose for each business combination that occurs in the current reporting period:

• Where synergies from combining operations of the acquiree and acquirer are expected, a description of synergies and of the expected timing of achieving those synergies, the amount (or range of amounts) of the synergies and the expected costs (or range of expected costs) to achieve the synergies (adding to IFRS 3:B64(e))
• The amounts recognised as of the acquisition date for each major class of identifiable assets acquired and liabilities assumed, stating that liabilities arising from financing activities and pensions obligations are considered to be major classes of liabilities assumed for the purposes of this disclosure requirement (amendment to IFRS 3:B64(i))
• The amounts of revenue, operating profit or loss before acquisition-related transaction and integration costs, and cash flow from operating activities of the acquiree, since the acquisition date included in the consolidated statement of comprehensive income and consolidated cash flow statement for the reporting period (amendment to IFRS 3:B64(q))

Discussion

The Board welcomed the general direction of the project, in particular the improvement of objectives. Board members acknowledged that preparers are reluctant to provide more disclosures, but the aim of the project should be to revisit existing disclosure requirements as well. As a consequence, some of the existing requirements might disappear. The requirements should encourage good behaviour, but cannot be too specific. Some of the disclosures suggested by the staff would result in boilerplate information, according to one Board member.

The Board members touched on some of the requirements suggested in the agenda paper and gave comments. In particular, the requirement to only provide information for acquisitions that are reviewed by the CODM caused some concern. The PIR on IFRS 8 Operating Segments proved that it is very difficult to base consistent disclosure on the management approach as there are opportunities for entities to circumvent undesirable disclosures. Some Board members thought that the concept in IFRS 8 is not robust enough to apply it to IAS 36 Impairment of Assets and IFRS 3. One Board member highlighted that the PIR on IFRS 8 revealed that there were different understandings around the world of who the CODM is. In the US, for example, it is traditionally one person, while in the rest of the world it could be several people. The word ‘review’ in the sense of what the CODM regularly reviews is also interpreted differently. A Board member said that there will always be some flexibility in the disclosure requirements. Another Board member suggested to consider to present a minimum of information, regardless of whether the CODM reviews that information or not. The Vice-Chair expressed concern that this discussion would re-open the discussion on IFRS 8, which is undesirable.

As regards the disclosure of how the key objectives of the acquisition have been achieved, some Board members thought that this would be onerous for acquisition-heavy entities, especially if it has to be done for a number of years. The staff responded that this was mitigated by the management approach. There was also concern about measuring the key objectives of the acquisition only on an entity-level, as some entities are integrated very quickly and then information on a bigger part of the business (up to an operating segment) would have to be disclosed. Once CGUs change and targets are broken up, the entity would be unable to track the individual acquisition information. One Board member said that the term ‘synergies’ would have to be defined as different entities have a different understanding of what synergies encompass. Another Board member suggested to examine why the predecessor Standard to IFRS 3 required an analysis of historical cost of the assets of the entity vs. the fair value of those assets. There might have been useful information in that requirement.

Some Board members found the disclosure of how an acquisition performs against expectations useful. Currently, underperformance of an acquisition should be captured by the impairment requirements, however, not every underperformance leads to an impairment. Improving the impairment test could help, but the Board agreed that more than that would have to be done. One Board member suggested that until the impairment test and the disclosures are improved, the Board should highlight to investors that goodwill is a very risky asset.

The Board also discussed whether there should be a review of the existing disclosure requirements in IFRS 3. The Board had previously decided that those should not be taken under review until after the Discussion Paper (DP) was issued, however, it will be difficult to perform a full analysis in the DP without touching on IFRS 3. This would also signal to practice that the Board is not only considering an increase of disclosures, but also a removal of unnecessary existing requirements. In addition it would show that the Board takes PIRs seriously. One Board member suggested to retain the requirement to disclose pro-forma information, given that users have confirmed that the information is useful. However, the Board member conceded that the Board should review this requirement to ensure that the most useful information is provided. The current requirements are not sufficiently clear to result in comparable information being provided.

The Chairman suggested to include in the DP a discussion around ‘tangible equity’, i.e. disclosure of the amount of equity before intangible assets. This would result in more reliable equity information as intangible assets are difficult to measure. Many Board members welcomed the idea and suggested that the staff explore this path. Some Board members also suggested to take the idea further and consider offsetting goodwill against equity, to which one Board member responded that the Board has always seen goodwill as an asset.

On amortisation, several Board members suggested to at least include the idea in the DP to get feedback from users.

As a next step, the staff will bring a paper to the May 2019 Board meeting that would ask the Board for its preliminary views on the issues to be discussed in the DP.

No decisions were made.

Cover note (Agenda Paper 4)

Agenda Paper 4A contains the project background and a summary of the Board’s discussions to date. See the December 2018 meeting summary for more details.

Agenda Paper 4B discusses whether the DRM model should preclude an entity from designating certain types of strategies within the target profile.

Agenda Paper 4C discusses how an entity should present the derivatives designated within the DRM model in its financial statements.

Summary of discussions to date (Agenda Paper 4A)

Background

The aim of the proposed DRM model is for financial statements to represent faithfully the effect of dynamic risk management activities undertaken by an entity. It aims to help users assess management’s performance by focusing on how well management was able to align the asset profile with the target profile using derivatives.

In November 2017 the Board tentatively decided that the DRM accounting model should be developed based on the cash flow hedge mechanics.

In December 2017 the Board tentatively decided the staff should develop the accounting model for DRM in two phases. In the first phase the IASB would focus on ‘core areas’ such as: (i) asset profile; (ii) target profile; (iii) derivative instruments used for DRM purposes; and (iv) performance assessment and recycling. In the second phase the focus would be on extensions of the concepts.

The first two of the ‘core areas’ were discussed during the February 2018, March 2018 and April 2018 Board meetings. The Board identified the qualifying criteria for financial assets in the asset profile and financial liabilities in the target profile.  The Board also tentatively decided on the allowable designations, reasons for de-designation and the documentation that should be completed before an entity starts applying the DRM model. The third and fourth ‘core areas’ were discussed during the June 2018 Board meeting. The Board tentatively decided on the types of derivatives that can be designated within the DRM model, their designation and de-designation and which derivatives will be addressed within the first phase of the DRM project. It also tentatively decided what information should be provided in the statement of profit or loss regarding DRM activities. The results should reflect the entity’s target profile in the case of perfect alignment and the reclassification should occur over the time horizon of the target profile (even in the case of voluntary discontinuation of the DRM accounting model). The Board tentatively decided that in order to apply the DRM accounting model, an entity must demonstrate that there is a continuing economic relationship.

During the September 2018 meeting, the Board discussed the measurement and assessment of imperfect alignment and how the DRM model should treat the change in risk management strategy. The Board tentatively decided that the assessment of the economic relationship should be in the form of qualitative thresholds supported by a quantitative analysis and that no ‘bright line test’ will be introduced to the DRM model. No single method of assessment was specified but an entity may compare the actual derivatives used with the benchmark derivatives. The minimum performance requirements and how they should be applied in the context of DRM model were discussed further during December 2018 meeting. At this meeting, the Board tentatively decided that an entity may apply the DRM model if designation of the asset profile, target profile and designated derivatives does not reflect an imbalance and there is an economic relationship. The Board emphasised its previous tentative decision not to define any quantitative threshold for an economic relationship and instructed the staff to seek feedback on the articulation of the strength of an economic relationship during outreach on the core model.

Staff recommendations

This paper is only educational and does not contain a staff recommendation.

Certain strategies and the target profile (Agenda Paper 4B)

In this paper, the staff discusses whether the DRM model should preclude an entity from designating certain types of strategies within target profile. The following are considered.

• (1) Leverage—the staff uses an example when the target profile is twice of the size of asset profile (when comparing notional amounts). In this case, an entity will need to designate derivatives to increase the notional of the asset profile. This would mean that derivatives were not used to transform the financial asset designated profile but were used to create the interest cash flows in the first place. The Board tentatively decided (March 2018) that the notional of the asset profile, derivatives designated in DRM model and the target profile must be equal.
• (2) Negative balances within target profile—the staff considers whether the designation of negative balances within the individual time buckets is allowed. The staff provides an example where the overall notional of asset profile and target profile are the same, but an entity allocates the negative amount to the first-time bucket and the much higher amount to the last time bucket. The staff tentatively concludes that the outcome of this strategy is similar to the leverage because derivatives are used to increase the size of the asset profile in the last time bucket.  
• (3) Changes in the risk management strategy—the staff expects that the changes in the risk management should be rare. The staff is of the opinion that any frequent changes would undermine the usefulness of information provided by the DRM model. The staff proposes that an entity should clearly define the target profile and the strategy that is following so it is obvious whether the change in risk management strategy occurred. Furthermore, the clear determination of the target profile and its time horizon will preclude entities from changing its risk management strategy to achieve a specific accounting outcome that would be inconsistent with the DRM model.

Staff recommendations

The staff recommend that:

• (a) negative balances within the target profile should not be permitted within DRM model;
• (b) the changes to the risk management strategy and the target profile must occur infrequently; and
• (c) the risk management strategy must be clearly documented within a specified time horizon and cannot be defined in a way that is contingent.

Discussion

There was no discussion about whether negative balances are permitted within DRM model. The staff only clarified that this is a qualifying criteria question, not when in the normal course of operation an entity finds itself overhedged and consequently with a negative balance in a time bucket because this will not disqualify the model and it will be measured and disclosed as imperfect alignment.

In respect of the second question whether the changes in risk management strategy should be infrequent and the risk management strategy should have clearly documented time horizon, a few members of the Board suggested clarifying what is meant by ‘frequent’ and be specific on the wording because frequent changes bring severe consequences, i.e. discontinuation of the DRM model. Furthermore, Board members suggested providing some examples and types of events that could affect the change of risk management strategy to give some context to the phrase ‘infrequently’.  One Board Member suggested that there should be a clearer analyse of what prompted the change in strategy and provided examples of triggers which should not cause discontinuation of the DRM model i.e. change in the product mix, macroeconomic change, result of periodic assessment of the effectiveness of DRM model.

In respect of documentation, a Board member stated that the DRM model would not work without specifying the time horizon. Another Board member was unsure what “must be clearly documented” means, i.e. at what level (seniority), what is the approval process for the properly documented strategy? In his view, the strategy should be approved at the highest level because this is a strategy and because it is a strategy and not just a reaction for a week of volatility, it should not occur frequently.

One Board member asked about changes in the operations which may occur over the time, evolutionary and not drastic change e.g. a commercial bank evolves into an investment bank causing that the tenor of assets to change and whether the target profile accommodates that or is that a change in strategy. The staff answered that changing to investment banking is pushing the boundary of applying the DRM model. However, if an entity changes the horizon of the target profile and there in no change in the type of the funding, this would be a change in the strategy.

Other Board members questioned whether the staff is trying to prevent specific behaviour, i.e. achieving a particular accounting outcome by changing the risk management strategy. The staff answered that the change will be captured by the accounting mechanics. However, this raises questions about the commitment to the long-term strategy if the strategy is changed frequently. Again, the analysis of triggers and rationale for change of the strategy are crucial.

One Board member indicated that frequent changes could be seen as akin to trading but this will mean different accounting for derivatives, i.e. changes in fair value recognised in other comprehensive income versus changed in fair value recognised in profit or loss. If frequent changes are allowed, then the accounting model will not represent true business model.

The staff added that this is no different from the concept of business model change or the transaction being no longer highly probable when the hedge accounting was disqualified prospectively. This is because the strategy is no longer what the model was trying to accommodate and the information given by the accounting is no longer accurate. It was repeated that in the phrase “clearly documented time horizon”, the time horizon is important in establishing when the amount from other comprehensive is reclassified to profit or loss and clear documentation will prevent any manipulation.

One Board member said that the DRM model is developed to address the issue of the long-term strategy, where the components of this strategy are changing regularly and are dynamic. If the strategy is changing every day, then this is not a long-term strategy with daily tuning only it is a short-term strategy more like trading. This should be explained because it relates to the problem that the Board is trying to solve. Then the requirements for application of DRM model will flow from that. 

The Board suggested some amendments to the question raised i.e. clarify that changes to risk management strategy should be infrequent in order to apply the DRM model and replace the phrase “must occur infrequently” with the phrase “is expected to occur infrequently”.

Decision

The Board tentatively agreed with the preliminary staff’s recommendations unanimously.

Presentation (Agenda Paper 4C)

In this paper, the staff discusses the presentation of amounts relating to the derivatives designated in the DRM model in the statement of financial position, other comprehensive income and in the statement of profit or loss.

Statement of Financial Position

The staff considers two possible approaches:

• (1) to disclose the information about derivatives designated in DRM model within the notes to the financial statements; or
• (2) to present the derivatives designated in DRM model separately from the other derivatives in the statement of financial position.

The two approaches can be supported by the requirement in paragraph 24 of IFRS 7 Financial Instruments: Disclosures to disclose separate information regarding hedging instruments designated in the hedge accounting relationships and paragraph 59 of IAS 1 Presentation of Financial Statements which requires entities to present the different classes of assets in separate line items.

The staff think that the function of the derivatives designated in the DRM model is different from those that are not designated and disaggregation would provide useful information. However, this would be more effectively communicated via disclosure than adding separate lines to the statement of financial position and increasing the length of the primary statement.

Other Comprehensive Income

The staff proposes that amounts included in other comprehensive income need not be shown as a separate line item in the statement of other comprehensive income. Note disclosure is more appropriate. The staff note that this is consistent with IAS 1: 82A and IFRS 7: 24B(b)(i). Entities are required to present separately the balances in relation to cash flow hedges or net investment hedges, but not ((in the Statement of OCI) the changes in fair value of the designated derivatives or reclassified amounts.  

Statement of Profit or Loss

The staff considers presentation of the aligned portion as part of an entity’s net interest margin.  Furthermore, the staff considers whether the misaligned portion should be presented as a separate line item within the statement of profit or loss or disclosed in the notes to the financial statements.

The staff acknowledges that the term ‘net interest margin’ is not defined in IFRS Standards but it is commonly used by financial institutions and is used to mean a subtotal that is net of interest income and interest expense derived from financial assets and liabilities. If an entity designates derivatives to transform the asset profile so it equals target profile, the amounts recognised in the income statement in relation to interest revenue from designated assets, interest expense from designated liabilities and the amounts reclassified from other comprehensive income in relation to designated derivatives are linked.  Therefore, separating these three items in the profit or loss could confuse the users of financial statements and would not faithfully represent the risk management actions of an entity in the financial statements. Furthermore, the staff considers apportioning the amount reclassified from the other comprehensive income by the affected hedged item. The staff rejects this approach because it would require separating the designated derivatives into components based on their fixed and floating leg. The staff proposes the following approaches: (i) allocate the full amount to interest revenue; (ii) allocate the full amount to interest expense or (iii) present the aligned portion as a separate line item (see chart 3 in the paper). However, the staff thinks that allocation or full amount with either interest revenue or interest expense is not appropriate because it would ignore the linked nature of the items designated and is in favour of separate presentation. As an additional argument to support its view, the staff uses the similarity with cash flow hedging on net positions under IFRS 9 Financial Instruments when the hedging gains and losses are presented in a separate line in the statement of profit or loss.  

In the case of any misaligned portion (over-hedge), the staff proposes not to include it within ‘net interest margin’ because they are in excess of those required to transform the asset profile such that it equals the target profile. The cash flows attributable to the misaligned portion serve a purpose other than risk management as it was tentatively agreed by the Board during its September 2018 meeting. Therefore, the treatment of aligned and misaligned portions should be different to present appropriately the risk management and its effectiveness. The staff further decomposes the misaligned portion into current period impact of misalignment and future period impact of misalignment and states that each of them conveys different information to users of financial statements.

The staff proposes three approaches regarding presentation of current and future misaligned portions, i.e.:

• (1) present both current and future misaligned portions as the separate line item in the statement of profit or loss;
• (2) present separately current and future misaligned portions as the separate line items in the statement of profit or loss; or
• (3) disclose them in the notes to the financial statements.

They recommend option (3). The staff’s rationale for such presentation is that only over-hedge would be clearly visible in the statement of profit or loss. An under-hedge (and due to using of ‘lower of test’) will be not noticed, giving the users of financial statements the wrong impression that an entity achieved a perfect alignment.

Staff recommendations

The staff recommend that:

• (a) disaggregation of derivatives designated in the DRM model from other derivatives should be communicated through disclosure rather than a separate line item in the statement of financial position;
• (b) the DRM accounting model should not require presentation of accumulated changes in fair value of designated derivatives in a separate line item within other comprehensive income, but this information should be clearly communicated to users through disclosure;
• (c) the aligned portion should be presented as part of an entity’s net interest margin in a separate line item in the statement of profit or loss. In addition, during the outreach, the staff should seek for feedback on whether the costs involved with separate presentation on the statement of profit or loss would merit the benefits of increased transparency; and
• (d) the misaligned portion should not be presented as part of an entity’s net interest margin. In addition, the DRM model should not mandate a specific line item for presentation of misalignment, but should require disclosure of that amount on a disaggregated basis and the line item in the statement of profit or loss where misalignment is presented.

Discussion

The staff emphasised that the recommendations are in the context of the core model i.e. to focus on the most important aspects of DRM model and to develop material for outreach and discussion that support future decisions.  

Statement of Financial Position and Other Comprehensive Income

Two Board Members disagreed with the staff recommendation and were of the opinion that the nature and function of the derivatives used in a DRM model are different and they should be presented as separate line items in the primary statements. This is important and should have higher focus than just a disclosure. However, they agreed that the concept of materiality should be applied.

One Board member indicated that if the nature and function of the derivatives is different then maybe they should not be presented as one line item. However, in his opinion, the nature of the derivatives is the same but they have different function and hence they should be disclosed.

One Board member indicated that the questions asked by the staff have two aspects—whether the information about the derivatives should be disaggregated and, if disaggregated, where they should be presented. On the disaggregation part, the Board member asked whether the staff is proposing separate presentation of derivatives designated in DRM from other derivatives designated in micro-hedges. The staff confirmed that this is the case. The staff was reminded to be clear with the wording and use the terms ‘presented’ in the case of Balance Sheet or Other Comprehensive Income and ‘disclose’ in the case of disclosures.   

The Board members agreed with the staff recommendation because this is the way to provide useful information about the DRM model. The balance sheet is a structured summary and it should not be overloaded with information. It was noted, that if an entity wishes to present derivatives used in DRM model as the separate line, it should not be prohibited. At the same time, it should not be required to present them as a separate line item.

The staff clarified that the information will be always there, it is just the case of emphasis put on that information which is different for something presented in the financial statements from something disclosed in the notes.

The Board suggested amending the wording in the question from “should be communicated through disclosure” into “shall not require presentation….” to be clear that the entities may presented the disaggregated DRM derivatives on the face of balance sheet.

Decision

12 Board members tentatively agreed with the staff’s recommendations.

Statement of Profit or Loss – aligned portion

One Board member indicated that there is a requirement to present separately revenue and finance cost, however interest margin is not a defined term in IFRS. The aligned portion should be presented as the separate piece of information on the face of income statement on the basis how important that is but it should not be required to be presented as the part of net interest income, which may differ, by entity.

One Board member indicated that the aligned portion will have to be presented as a separate line because it is different in nature, i.e. it is fair value of derivatives and not interest revenue or interest expense.

Another Board Member indicated that the staff has to be careful with the terminology used in the paper. For example in the investment markets: ‘net interest margin’ is commonly understood as ‘net interest income’ and ‘the net interest margin’ would be “interest income over average earning assets”. Hence, it was slightly confusing for him. He agreed with the staff recommendation to present the aligned portion as a separate line item. The Board member indicated that the users would like to calculate ‘net interest margin’ pre- and post- of the effects of the DRM model and therefore he suggested putting the aligned portion at the bottom of the three items.  In respect of term ‘net interest income’, he suggested to include that in a new project.

Several times the parallel Primary Financial Statement (PFS) project was mentioned and whether presentation will be left for PFS project, whether the outcome of that project should feed into the DRM project or the projects will be integrated. The DRM discussion paper might acknowledge the PFS project. 

One Board member agreed with the staff recommendations on the understanding that the separate line items and the ‘net interest margin’ will accommodate all hedging activities of an entity, i.e. including micro-hedging because in other way there will be too many line items and too many sub-totals. Other Board members clarified that the revised question does not ask about sub-totals, but only whether the aligned portion of DRM derivatives (and only those derivatives) should be presented separately. Furthermore, the staff explained that the requirement to present separately all derivatives used for hedging would mean significant change and will not necessarily reflect the economics of the micro-hedges. Furthermore, it is not in the scope of Paper 4C.

The staff explained that the outreach will be a full discussion and it will happen before the DP will be issued. The idea is to test the model during outreach.

One Board member suggested asking during outreach about the usefulness and importance of the ‘net interest income’ sub-total for the users before doing anything more in about it during the DRM project.

The staff agreed that it should be clarified during outreach that even if an entity were perfectly hedged, the target profile would be not shown on the face of profit or loss because the book may be bigger than what is in the scope of DRM model. This will become even more relevant beyond the core model because if an equity’s book was included, this is a funding source and not source of interest income or expense.

The staff repeated that what they are proposing is that there has to be separate line item for an aligned portion of the DRM derivatives and that it has to be clear that the separate line item relates to both interest rate income and interest expense. The staff agreed with the Board members that the better place to show the relationship between those items is within the notes to the financial statements. The staff agreed that during an outreach they would not ask specifically about the presentation hence the Board was not asked to vote on that element of the original question. 

Decision

13 Board members tentatively agreed with the above staff’s recommendations and one abstained. 

Statement of Profit or Loss – misaligned portion

One Board member indicated that he would not ask for separate presentation or even for the specific disclosure of the disaggregated bit of misalignment because there is not much information value in that.

The Board members agreed that the misaligned portion should not be presented in the same manner as the aligned portion of DRM derivatives because in this way the information value will be lost. However, some Board members were in the opinion that the misaligned portion should be presented on the face of the income statement because there are two purposes, i.e. to present whether this is a good or bad strategy and how much the misalignment has contributed to the bottom line. These numbers may be big and quite volatile and should be seen not as part of an entity normal activity only it should be seen as part of DRM model that was not successful. Again, it was confirmed, if material, it should be separately presented. 

The staff explained that they are not proposing to hide any misalignment, it is a matter of emphasis and in the staff’s view the notes are good enough to include this information.

Decision

On the question whether the misaligned portion should be communicated clearly that is not part of the aligned portion, 13 Board members voted in favour and one abstained. 

On the question whether the DRM model should require that the misalignment has a separate line item on the face of income statement, three Board members voted in favour and one abstained.

On the question whether the amount of misalignment should be separately communicated through disclosure, 11 Board members voted in favour and one abstained.