Notes from the January 2007 IFRIC meeting

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15 Jan 2007

The International Financial Reporting Interpretations Committee (IFRIC) met at the IASB's offices in London on Thursday and Friday 11 and 12 January 2007. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the meeting.

Notes from the IFRIC Meeting11-12 January 2007
Thursday 11 January 2007

 IFRIC Due Process Handbook
The IFRIC discussed the draft text of the Due Process Handbook reflecting the recommendations made by IFRIC members in November and by Board Members in December 2006.
The discussion focussed on the agenda setting process and the authoritative status of Agenda Decisions.
In December the Board suggested that the Agenda Committee should be absorbed into the IFRIC and that the IFRIC public meetings should include an initial discussion of issues raised as potential agenda items. Some IFRIC members noted that the process of discussing potential agenda items had not been explained in detail in the Due Process Handbook and raised the concern that the omission of separate agenda meetings in between of (ordinary) IFRIC meetings might extend the period between the submission of issues to IFRIC and the first public discussion. The Chairman pointed out that it is not intended to have additional agenda meetings but that all submissions to IFRIC are now discussed as part of the public IFRIC meetings. He did not agree that this procedure will slow down the process.

Finally, the IFRIC agreed to the Board's suggestions but suggested to include an additional paragraph explaining the agenda setting process.

With regard to the authoritative status of Agenda Decisions the IFRIC reaffirmed their view that Agenda Decisions are non-authoritative statements and that it is not intended to introduce an additional level of guidance.

The IFRIC agreed that the Due Process Handbook would be amended according to the comments made by the IFRIC during this session. A proposal will be presented to the IASC Foundation Trustees at their meeting in January 2007.

IAS 19 Employee Benefits - Distinction between Curtailments and Past Service Costs

The IFRIC discussed a request to provide guidance on whether plan amendments that reduce benefits are accounted for as curtailments or as negative past service costs. In particular, they deliberated which of the following views would be in compliance with the current version of IAS 19:

View A:

  • Any plan amendment should be considered in its entirety. If an impact of the amendment is to reduce the benefits for future service then the amendment meets the definition of a curtailment. IAS 19.98(e) excludes the impact of curtailments from the definition of past service cost. Therefore the full impact of any plan amendment which reduces benefits for future (and past) service should be accounted for as a curtailment.

View B:

  • Follow view A but apply this at the individual member level rather than for the plan as a whole. Therefore the impact for any retiree, terminated, or active member who has passed the date when further service leads to no material amount of further benefits (as specified in IAS 19.67(b)) should be accounted for as a negative past service cost whilst the impact for other active members should be accounted for as a curtailment.

View C:

  • The reference in IAS 19.98(e) should be read as excluding only future service impact when considering a curtailment. Therefore the impact of any plan amendment should be broken down into elements which relate to past service (for example, accrual rate) and elements which are dependent on future service (eg the impact of future salary increases included in the defined benefit obligation or the impact on the calculation of the defined benefit obligation of straight lining a benefit accrual which includes a back end load in accordance with IAS 19.67). Having bifurcated the plan amendment into mutually exclusive past and future service elements, negative past service cost or curtailment accounting treatment is applied for the respective elements.

After a thorough debate the IFRIC was nearly equally divided between views A and C.

The IFRIC came to the conclusion that amending IAS 19 would be the most efficient way to resolve the issue. It was noted that deleting the last sentence of the definition of past service in paragraph 7 of IAS 19 stating that past service costs "may be either positive (where benefits are introduced or improved) or negative (where existing benefits are reduced)" would possibly resolve the problem.

The IFRIC directed the staff to prepare a paper considering the implications of amending paragraph 7 of IAS 19 in such a way.

IFRIC D20 Customer Loyalty Programmes: Analysis of comment letters – Overview, separate component approach and scope

The IFRIC discussed comments received on the Draft Interpretation D20 Customer Loyalty Programs.

The discussion focussed on the following aspects (the discussion overlapped):

  • a. The overall approach proposed (which would require award credits to be accounted for as a separate component of the sale in which they are granted)
  • b. The proposed scope

Overall approach and project scope

Of the 52 comment letters expressing a view on the overall approach, 16 commentators were supportive of the proposed separate component approach, 20 commentators advocated a mixed approach – that is, the separate component approach should be required only for some types of loyalty programme, with a cost accrual approach being permitted or required for others; and 16 commentators favoured a cost accrual approach for all customer loyalty programs.

The commentators advocating a mixed approach suggested to scope out particularly:

  • Marginally managed programs mainly because of the significant practical difficulties in measuring the fair values of the award credits
  • Awards comprising items that are not sold by the entity in course of the ordinary activities
  • Awards that are incidental

The commentators favouring a cost accrual approach for all customer loyalty programs argued that

  • the substance of all, or the vast majority of, customer loyalty programmes is that of a marketing expense rather than a sale and that the customer does not see the transaction as comprising two separate sales,
  • fair values cannot always be measured reliably, and
  • the proposed revenue deferral approach would be complex to implement.

Of the 25 respondents specifically commentating on the scope only one respondent considered the scope to be right. The comments on scope fell into two main categories:

  • The scope is dealing with a specific arrangement, not with clearly identified principles. The respondents raised concerns that the conclusions may be inconsistent with solutions for similar arrangement (for instance, service concession arrangements) or that the conclusions may be unreasonably applied to other arrangements like gift vouchers sold and prepaid phone contracts.
  • The economic arrangement is not correctly covered by the scope of the interpretation. The main concerns were:
    • Some features of customer loyalty programmes (points granted to customers without being directly linked to a sale, welcome points, birthday points, etc.) would be excluded
    • Some items are included in the scope that should not be, for example, marketing expenses, awards for goods and services that are not separately sold by the company, immaterial items. Additionally, only business to customer arrangement should be in scope.
    • Some parts of the economic arrangements are not addressed, for example, accounting for the third party when the award is provided by a third party, multiple company programmes like the UK programme NECTAR and accounting treatment for points sold between companies.

The IFRIC unanimously decided to proceed with the proposed separate component approach and the scope.

It was assumed that some of the concerns raised were caused by misunderstandings and, therefore, the IFRIC decided to give more detailed guidance in particular on the following issues:

  • Explicitly point out that marketing expenses are not in the scope of D20
  • Give more detailed guidance on how to deal with customer loyalty programs in which the entity has engaged a third party to supply the awards
  • Make clear that D20 does not relate to immaterial award credits
  • Address multiple company programmes

With regard to the scope, the IFRIC noted that it is vital that it needs to be assessed for every component of customer loyalty activities whether this component is in the scope of D20. It appeared that the IFRIC is, therefore, reluctant to include illustrative examples in D20.

The staff was asked to amend the draft Interpretation accordingly.

IAS 41 Agriculture - Recognition and Measurement of Biological Assets Under IAS 41

At its November meeting, the IFRIC agreed to recommend to the Board that it amend IAS 41.21 to remove the prohibition on taking into account additional biological transformation when using discounted cash flows to measure the fair value of a biological asset.

The staff presented a paper recommending the following amendments to paragraph 21 of IAS 41:

An entity may use present value techniques The objective of a calculation of the present value of expected net cash flows is to determine the fair value of a biological asset in its present location and condition. If so, an entity includes the net cash flows that market participants would expect the asset to generate in its relevant market. However, the present value does not include any cash flows from finance costs or income tax expense, or from re-establishing biological assets after harvest (for example, the cost of replanting trees in a plantation forest after harvest). An entity considers the risk associated with bringing the asset to the condition and location in which it will be sold in the relevant market in determining an appropriate discount rate to be used and in estimating expected net cash flows. The present condition of a biological asset excludes any increases in value from additional biological transformation and future activities of the entity, such as those related to enhancing the future biological transformation, harvesting, and selling.

The discussion focused on the determination of the relevant market for immature biological assets which was the subject of the initial submission to IFRIC. The majority of the IFRIC members seemed to agree that an active scrap market is not the relevant market for immature biological assets if the biological asset is expected to be grown to maturity and to be sold in a market for mature biological assets. In this case a market for mature biological assets would be the relevant market.

The IFRIC noted that paragraphs 17 to 21 of IAS 41 need to be read in context and that an additional amendment of paragraph 17 of IAS 41 might clarify this issue. It appeared that they recommended changing the first sentence of paragraph 17 of IAS 41 to something like: "If an active market exists for a biological asset or agricultural produce in its present condition, the quoted...". In addition a reference to this sentence should be included in paragraph 21 of IAS 41.

No decisions were made, but IFRIC directed the staff to revise the amendments accordingly for discussion at a future meeting.

IAS 39 Financial Instruments: Definition of a Derivative – Indexation on own EBITDA or own revenue

The IFRIC was asked to provide guidance on whether a contract that is indexed to an entity's own revenue or own earnings before interest, tax, depreciation, and amortisation (EBITDA) meets the definition of a derivative under IAS 39. In November 2006 the IFRIC decided not to confirm its tentative agenda decision on this issue, but to undertake further investigation.

The staff addressed the following questions to the IFRIC:

  • Does the exclusion from the definition of a derivative of contracts that are linked to non-financial variables that are specific to a party to the contract only apply to insurance contracts?
  • Does EBITDA or revenue represent a financial or non-financial variable?

The IFRIC agreed to recommend to the Board that it amend paragraph 9 of IAS 39 by adding guidance that the exclusion from the definition of a derivative of contracts that are linked to non-financial variables that are specific to a party to the contract only applies to insurance contracts.

It was decided to take no further action at this stage but to await the Board decision.

IAS 18 Revenue: Revenue Recognition in Respect of Initial Fees

The IFRIC discussed the draft text of a Draft Interpretation and related Basis for Conclusions.

The discussion focused on the identification of initial and ongoing services and the consideration of the legal arrangements, for example, the situation that a fund manager receives its up-front fee from an investor and its ongoing fee from a fund. The IFRIC could not agree on a principle that would be applicable to all situations where a selling entity receives a fee and then provides an ongoing service whether or not such service is subject to the payment of further fees.

The IFRIC concluded that it could not reach a consensus on this matter on a timely basis and for this reason decided to remove the project from its agenda.

Friday 12 January 2007

IAS 38 Intangible Assets: Treatment of Catalogues and other Advertising Costs

The IFRIC discussed staff proposals that put into effect the November 2006 decision to recommend to the IASB that IAS 38 be amended to clarify that advertising and promotional expenditure should be recognised as an expense when the advertising is distributed to customers. The staff had raised with the IFRIC several implications of such an amendment and the potential for further inconsistencies.

The IFRIC was uncomfortable with the staff proposals and did not support them. Some members were concerned that the proposals represented an unacceptable expansion of the scope of the project. Others were worried about the potential divergence from US GAAP. Some saw the proposals as an over-complicated method for accounting for what were, in essence, prepayments.

The IFRIC noted that there was an incompatibility of language between IAS 38.69 and 38.70. A majority of IFRIC supported an approach that would amend IAS 38 to clarify that advertising and promotional material (only) is recognised as an expense when consumed by the entity (that is, when it is first delivered to customers).

IAS 21 Foreign Exchange: Hedging a Net Investment

The IFRIC held its first substantive discussion on a project to provide guidance on the accounting for a hedge of a net investment in a foreign operation in group financial statements.

Should the IFRIC clarify whether IAS 21 indicates a method of consolidation?

The IFRIC discussed whether the mechanics of consolidation (for example, consolidate subsidiaries into intermediate parent companies before consolidating those intermediate parents in to the group parent (two-step) vs consolidate all subsidiaries in to the group parent directly (one-step)) should make a difference to this issue. After debating this issue for a while, the IFRIC decided that this was a separate issue and should not be considered as part of the Interpretation on hedging a net investment in a foreign operation.


What is the hedged risk?

After debate, the IFRIC agreed that what is being hedged is the net investment in the foreign operation, which is not necessarily either a cash flow hedge or a fair value hedge. Net investment hedging is a separate category of hedge accounting.

Which currency?

The IFRIC agreed that a hedge of a net investment in a foreign operation is hedging the risk between the functional currency of the foreign operation and the functional currency of the reporting parent company. That is, if an intermediate parent company must prepare general purpose financial statements, it can hedge its net investment in a foreign operation on the basis of the intermediate parent's functional currency, even if that currency is different from that of the ultimate group parent company.

Where can the hedging instrument be held?

The IFRIC agreed that it did not matter where within the consolidated group the hedging instruments were held. In addition, some IFRIC members and Board observers were of the view that it was not necessary that the functional currency of the entity holding the hedging instrument and the parent should be the same. (This is a potential difference with US GAAP.) IFRIC members also noted the existing guidance in IAS 39 IG.F.2.14, which addresses intragroup hedging activities.

Senior IFRIC staff was uncomfortable with this conclusion and thought that some restriction on where the instrument could sit within the group is necessary. It could be that where within the consolidated group the hedging instrument was situated might affect the amounts recognised in the financial statements and financial statement geography. The IFRIC will discuss these issues at a subsequent meeting.

The project staff asked whether the IFRIC was interested in the alternative of adopting the US GAAP requirements for net investment hedging. There was no support for this idea.

The IFRIC will continue the development of a Draft Interpretation at a subsequent meeting.

Review of Tentative Agenda Decisions Published in November 2006 IFRIC Update

IAS 39 Financial Instruments: Recognition and Measurement: Short Trading

The IFRIC redeliberated its Tentative Agenda Decision in light of comments received. In particular, several investment/retail banks had responded, highlighting practical difficulties that could result from the implementation of the Agenda Decision as drafted. In particular, there was the potential for a significant amount of additional data gathering and reporting (of the gross short and long positions, principally on intra-day trading) for very little informational gain. While expressing a high degree of sympathy for this particular constituency, the IFRIC noted that the accounting by the counterparty was equally important as that of the market-maker.

The IFRIC confirmed that it did not wish to develop an Interpretation. However it agreed that the Agenda Decision would be redrafted and re-issued.

IAS 39: Financial instruments puttable at an amount other than fair value

The IFRIC confirmed its Tentative Agenda Decision.

IAS 39: Derecognition of Financial Assets

The IFRIC redeliberated its Tentative Agenda Decision in light of comments received. The staff noted that, notwithstanding the publication of the IASB's views, there is still considerable confusion about how to apply the derecognition requirements of IAS 39. As a consequence, the IFRIC agreed with the staff proposal that the item should be added to the IFRIC agenda. The scope of any Interpretation should be limited to the following areas:

  • The application of paragraph 18 of IAS 39 to transfers of different types of financial assets (including transfers that include derivative financial instruments that can be assets or liabilities);
  • Whether the risk and rewards tests in paragraph 20 of IAS 39 should be applied separately to different types of financial assets transferred in the same transaction; and
  • Whether paragraph 18(a) or paragraph 18(b) of IAS 39 applies to a transfer of a financial asset.

One of the IASB Observers cautioned the IFRIC that such a project could consume significant resources if not properly scoped and managed. It was imperative to meet with the securitisation industry to ensure that any guidance likely to be developed would be useful. The IFRIC agreed and asked the staff to attempt the scoping exercise after meeting with securitisation experts.

Staff Recommendations on Potential Agenda Items

IAS 17 Leases: Sale and lease-back transactions with repurchase agreements

When it was developing IFRIC 12 Service Concession Arrangements, the IFRIC reached the conclusion that a transaction that took the form of a sale and leaseback should not be accounted for as such if it incorporated a repurchase agreement. The reason was that the seller/lessee would retain effective control of the asset by virtue of the repurchase agreement. Hence the criteria for recognising a sale in paragraph 14 of IAS 18 Revenue would not be met. At its May 2006 meeting the IFRIC decided that this conclusion would apply more widely than to service concession arrangements and that the matter should be the subject of a separate project.

The IFRIC agreed that it should not develop an Interpretation on this issue. The Agenda Decision would state, among other things, that:

  • It is not necessary to demonstrate that the sales criteria in IAS 18 paragraph 14 have been met before a transaction is treated as a sale and leaseback transaction
  • When a sale and leaseback transaction includes a repurchase agreement or a repurchase option whose exercise is almost certain, the seller/lessee should consider whether the arrangement conveys a right of use. IFRIC 4 and SIC 27 provide relevant guidance on the application of IAS 17 in this situation
  • If a sale and leaseback transaction includes a genuine repurchase option (that is, an option whose exercise is not almost certain), the transaction is within the scope of IAS 17 and should be accounted for as a sale and leaseback transaction.

IAS 19 Employee Benefits: Special wages tax

The IFRIC discussed revised Agenda Decision wording on the issue of how to account for a tax on pension costs. The IFRIC confirmed its decision not to develop an Interpretation and concurred with the draft Agenda Decision.

IAS 36 Impairment of Assets: Identifying cash-generating units in the retail industry

The IFRIC discussed the potential diversity in practice on identifying cash generating units in retail companies. Some retail companies define a CGU as a single store, arguing that each store has a different customer base and point to Illustrative Example 1A of IAS 36 Impairment of Assets. Others define a CGU as a whole chain arguing that cash inflows are not independent on a single store basis and that pricing, combined with other factors, is the significant driver to generate cash inflows. The staff noted that IAS 36 is definitive in that it is the existence of independent cash inflows more than anything else that identifies a CGU.

The IFRIC agreed not to add this item to its Agenda. A draft Agenda Decision will be issued in the forthcoming IFRIC Update.

IAS 39: Written options in retail energy contracts

The IFRIC considered a request to provide guidance on what constitutes a written option under paragraph 7 of IAS 39 in the context of energy supply contracts to retail customers and whether such contracts are in the scope of IAS 39. The IFRIC noted that retail customers do not have the ability to settle 'net'-they must settle their energy bills in cash or other assets. Consequently, the 'written option' implicit in an energy supply contract (the power will flow to the lights when the switch is 'on') is not a written option within the context of IAS 39.

The IFRIC agreed not to add this item to its Agenda. A draft Agenda Decision will be issued in the forthcoming IFRIC Update.

IAS 39: Assessing hedge effectiveness of an interest rate swap in a cash flow hedge

The IFRIC considered a request to provide guidance for the situation in which an interest rate swap with a non-zero fair value is designated as a hedging instrument in a cash flow hedge and whether an entity is allowed to consider only changes in the undiscounted cash flows of the hedged item and the hedging instrument (that is, no consideration of the time value of money) in assessing hedge effectiveness for hedge qualification purposes.

The IFRIC agreed with the staff's conclusion that, when an interest rate swap is designated as a hedging instrument in a cash flow hedge, the time value of money should be considered in order to take into account the timing of interest payments or receipts. In addition, IAS 39.74 does not allow the bifurcation of a single fair value of an interest rate swap for hedge designation purposes, unless the hedging instrument designated is an option or a forward contract.

The IFRIC agreed not to add this item to its Agenda. A draft Agenda Decision will be issued in the forthcoming IFRIC Update.

March 2007 IFRIC Meeting

The IFRIC Chairman noted that it is likely that the March 2007 IFRIC meeting will be extended to accommodate a public, non-executive session of the IFRIC. This session would be an opportunity for the staff to discuss with IFRIC members potential agenda items prior to the staff making a formal recommendation to the IFRIC about whether a topic should be added to the IFRIC's Agenda. This would be confirmed subsequent to the January 2007 IASC Foundation Trustees' meeting, during which amendments to the IFRIC's due process and operating procedures would be discussed.

This summary is based on notes taken by observers at the IFRIC meeting and should not be regarded as an official or final summary.

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