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IAS 12 — Recognition and measurement for unrealised losses for debt instruments measured at FV

Date recorded:

The staff introduced the paper by explaining that the purpose of Staff Papers 2 and 2A is to develop an approach on how to clarify the accounting for DTAs for unrealised losses on debt instruments measured at FV. This Staff Paper does not include a draft amendment to IAS 12. The staff plans to present a draft amendment that considers the results from the discussions of the Interpretations Committee in January 2014 at a future meeting.

There are three approaches presented in the paper for a specific case scenario:

Fact pattern:

Entity A invests CU1,000 at the beginning of Year 1 in a debt instrument with a nominal value of CU1,000 payable on maturity in 5 years.

Interest is paid at the end of each year at a rate of 2 per cent, taxable when received. The contractual interest rate of 2 per cent equals the market interest rate at the beginning and the end of Year 1. The market interest rate increases at the end of Year 2 to 5 per cent, which results in a fair value of the debt instrument at the end of Year 2 of CU918. The shortfall is due solely to the difference between the market interest rate and the nominal interest rate of the debt instrument, ie Entity A does not consider the debt instrument to be impaired.

The debt instrument is held in a business model in which assets are managed both in order to collect contractual cash flows and for sale and is classified in the ‘fair value through other comprehensive income’ category (‘FVOCI debt instrument’).

Tax law does not allow Entity A to deduct the loss until it is realised, ie by selling the debt instrument or by failure of the issuer to repay the principal. The applicable enacted tax rate is 30 per cent.

Entity A has no transactions in Years 1–5 other than the ones related to this debt instrument. It therefore has no other sources of future taxable profits on which to justify the recognition of the deferred tax asset.

Approach 1: no DTA is recognised if Entity A expects that it will hold the debt instrument to maturity and believes that it will collect all the contractual cash flows and thus recover the carrying amount of the debt instrument. The difference of CU82 between carrying amount and tax base does not give rise to a deductible temporary difference (DTD) because it is an unrealised loss.

Approach 2: A DTD arises irrespective of the expected manner of recovery. Entity A would recognise a DTA of CU25 at the end of Year 2 for the difference of CU82 between the carrying amount of the debt instrument of CU918 in the statement of financial position (ie FV) and its tax base of CU1,000 at that date. This is because the repayment of the principal of CU 1,000 at maturity is a taxable economic benefit and the entire tax base of the debt instrument of CU 1,000 can be offset against this taxable economic benefit. Consequently, the temporary difference of CU82 is deductible against the receipt of the principal when determining taxable profit in future periods. This approach includes an exception - if the entity expects to be in a loss position such that the temporary difference does not reduce future tax payments (but instead only avoids higher tax losses), a DTA should not be recognised.

Approach 3: On the basis of an approach that results in an outcome that is consistent with the one that was recently proposed by the FASB, the ‘consistent outcome’ approach, Entity A would recognise a DTA of CU25 at the end of Year 2. Contrary to approach 2, Entity A would also recognise this DTA when it is in a loss position. This is because the utilisation of DTDs related to unrealised losses of FVOCI debt instruments is assessed separately from the utilisation of other DTDs.

Staff Recommendation: At its meeting in May 2013, the Interpretations Committee decided to recommend to the IASB that the amendment to IAS 12 should be based on approach 2 ‘DTD irrespective of expected manner of recovery’, because it is based on the existing utilisation assessment in paragraph 24 of IAS 12.

Comments from IC members:

Several members indicated their support for the proposed amendments and would like to see the wording of the amendments and examples to better understand the implications.

One member expressed concern why this amendments would only be applicable to assets carried at FVOCI but not to other assets carried at fair value.

The chairman asked whether the members have any objection and there were no objections raised.

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