Development of an effective infrastructure to support the use of International Financial Reporting Standards, in particular with respect to consistent application, interpretation and enforcement of these standards with the final objective of avoiding reconciliation with local GAAPs.

Votes on Matters Discussed on 3 June 2004

On the first day of the meeting the IFRIC had been unable to form a quorum for large parts of the day due to three of the members being in attendance at the IASCF Constitutional Public Hearings in New York. At the beginning of the second day the staff outlined the major conclusions drawn on day 1 in respect of D3 Determining Whether an Arrangement Contains a Lease, and D7 Employee Benefit Plans with Promised Returns on Contributions or Notional Contributions. The IFRIC was asked to vote on the decisions in respect of these items as described above, and the motions were carried.

IFRS 2, IAS 19, and Employee Benefit Trusts

The IFRIC considered two draft interpretations amending the scope of SIC-12 Consolidation – Special Purpose Entities. The first interpretation proposes to delete the scope exclusion for equity compensation plans. The second proposes to delete the scope exclusion for equity compensation plans and to extend the scope exclusions relating to post-employment benefit plans to also exclude other long-term employee benefit plans. The IFRIC were in agreement that the second alternative was preferable, but believed the urgency to be placed on the deletion of the equity compensation plan scope exclusion was sufficient that if they were unable to determine appropriate wording for the second proposal that the first proposed draft interpretation should be issued.

The IFRIC debated the objective of the second proposed amendment, and agreed that it was to explicitly exclude employee benefit plans from consolidation when the accounting for those plans is already mandated by IAS 19. Following this debate the staff proposed the following scope exclusion paragraph be used:

This Interpretation does not apply to post-employment defined benefit plans and other long-term employee benefit plans with plan assets that are required to be included in the measurement of a defined benefit liability or a liability for other long-term employee benefits in accordance with paragraphs 54 and 128 of IAS 19 respectively.

The IFRIC agreed that, subject to editorial comments, the suggested scope exclusion paragraph was appropriate, and agreed that the draft interpretation incorporating this paragraph be sent to Board members for comment and, subsequent to that process, issued with a 75 day comment period.

Service Concessions

The IFRIC were presented with a number of papers on service concessions covering the following topics:

• Overview
• Service concession assets - a control perspective
• The intangible asset model and the alternatives
• Detailed accounting issues on the alternative models
• Examples

At previous meetings, the IFRIC had identified three potential models for accounting for service concessions:

• The physical asset model: On completion of construction the concession operator recognises the physical asset as its own.
• The receivable model: On completion of construction the concession operator recognises a right to receive cash as a result of the construction of the physical asset (the control of the physical asset passes to the concession provider).
• The intangible asset model: On completion of construction the concession operator recognises an intangible asset – effectively the licence to operate the physical asset (the control of the physical asset passes to the concession provider), as a result of its construction activities.

Service concession assets – a control perspective

The IFRIC debated a paper that considered, from a control perspective, which party should recognise the infrastructure assets as its own. The paper suggested that in the context of a service concession arrangement, CP (the Concession Provider), controls a property owned by CO (the Concession Operator) if CP (including parties related to it) both:

(a) controls or regulates what services CO must provide using the property, to whom it must provide them, and at what price; and

(b) will control, through ownership, beneficial entitlement or otherwise, the residual interest in the property at the end of the concession.

CP might also control a property owned by CO in other circumstances.

The IFRIC expressed general discomfort with these principles, including a concern that the model may not be consistent with existing GAAP, particularly in cases where CO is to operate an existing asset rather than construct a new one. They debated the merits of this proposal at length, particularly the practical application of the price control criteria. They determined that the items mentioned in the paper certainly formed a list of indicators that control might rest with CP even where legal ownership rests with CO, but not all were convinced that the criteria cited above should be used in the eventual interpretations. However, the IFRIC agreed to use the criteria above as its working model, with the intention that these criteria will be revisited once they have been tested, along with the other proposals, against examples.

The intangible asset model and the alternatives

The IFRIC debated a paper which proposed that the intangible asset model will apply most commonly in practice. The physical asset model will seldom apply because, on the basis of the control analysis discussed earlier, the physical asset will normally be on the books of CP. The receivable model will apply in situations where CO has a right to receive cash (the right to operate the road and thus derive cash does not result in a receivable). Therefore in most circumstances the intangible asset model will apply. A majority of IFRIC members tentatively supported this model. All were keen, however, to see the model tested against a variety of examples before reaching their final conclusions.

The basic illustration of the intangible asset model used is:

• CO constructs a road with a cost to construct of 100.
• The fair value of the road at the completion of construction is 110.
• Operating costs over the life of the concession are 70, and cash inflows will be 200.
• At the completion of construction CO transfers the road to CP and receives as consideration an intangible asset – the licence to operate the road.
• As this is a transfer of dissimilar assets (a road for an intangible), it must generate revenue measured at fair value of the asset given up in accordance with IAS 18. Therefore CO recognises revenue of 110, an intangible of 110, and therefore has a profit on construction of 10.
• Over the life of the concession CO receives 200 in cash, and pays 70 in operating costs, and amortises the intangible asset of 110, resulting in a profit of 20. Therefore total revenues for the contract are 310, and total profit is 20.

A number of IFRIC members were very concerned about the recognition of the 110 revenue on completion of construction, as it seemed counterintuitive to them that an entity could recognise revenue and a profit on construction of an asset to be used in its own activities. However, most IFRIC members conceded that, although they were uncomfortable with this, an exchange of dissimilar goods and services does occur at the completion of construction, and accordingly revenue (and consequently profit or in other circumstances loss) on the transaction must be recognised.

Two IFRIC members indicated their intention to dissent from the interpretations if the interpretations conclude that total revenues on the concession of 310 should be recognised. The staff agreed to consider for IFRIC's debate at a future meeting, whether the use of the intangible asset model absolutely necessitated the recognition of the 110 construction revenue, or whether there might be some way in which the total revenues recognised under this model were equivalent to the total cash flows (that is, in the example above, 200).

The papers presented to the IFRIC also contemplated the accounting for transactions by CP. The IFRIC debated whether they should address the accounting by CP, given that CP is often a public sector entity that in many jurisdictions would not apply IFRS. The IFRIC concluded that contemplating the accounting by CP was useful in testing the appropriateness of the proposals by CO, and also noted that in some transactions and jurisdictions CP would be required to apply IFRS.

The IFRIC discussed at what point under the intangible asset model, the intangible asset should be recognised. The options presented to them were:

• Recognition of an intangible on day 1 with a corresponding liability reflecting the outstanding construction obligation.
• Recognise a receivable over the period of construction which is then recognised as an intangible at the completion of construction.
• Recognise an intangible asset over the period of construction.

The IFRIC generally favoured the recognition of a receivable over the period of construction in cases where revenue would be recognised on the construction phase, and recognition of an intangible over a period where no revenue would be recognised on the construction phase. Accordingly final conclusions on this are dependent on the final conclusions about the appropriateness and operation of the intangible asset model. The IFRIC did note that where a receivable was recognised that would be settled other than in cash this would need to be distinguished from other receivables that are financial assets in the balance sheet.

The IFRIC considered the accounting for restoration obligations. The staff had suggested that obligations to construct new assets, or enhance new or existing assets to a condition better than at the start of the concession should be recognised as part of the cost of the intangible. This was differentiated from the situation of subsequent expenditure generally under IFRS, because it is actually a cost of obtaining the licence to agree to these obligations, and IFRIC generally supported this approach.

Where general restoration obligations exist, it was proposed that these be recognised over the life of the concession arrangement. This would mean amounts recognised at a particular point in time may be positive or negative depending on where in the restoration cycle the entity is. The IFRIC expressed some discomfort with this view, and that they believed it amounted to income smoothing. However, they did agree that at a point in time an assessment should be made as to whether any restoration obligation exists and if one did it should be recognised with the corresponding expense being recognised in profit and loss.

Examples

The IFRIC then went on to discuss some examples and whether they were in agreement with the application of the models to those examples. They concurred that subject to further exploration of revenue recognition issues described above, the staff had accurately applied the models to the few examples they were able to examine before the available time for the discussion expired.

Because of time constraints the IFRIC did not get an opportunity to discuss:

• How CP should account for its sale of the intangible asset.
• The treatment of finance costs.
• The treatment of assets contributed by CP to CO.
• The impact of other contractual obligations of CO.

The staff will proceed with preparing draft interpretations for consideration at the July meeting, on the basis of decisions taken to date.

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

Scroll down for notes from 3 June 2004.

EFRAG is united in supporting all significant aspects of IAS 39 relating to recognition and derecognition of financial instruments, fair value measurement and impairment, the implementation of which is likely to lead to improved financial reporting in Europe.

In particular, all members of EFRAG, and the three European national standard setters represented on EFRAG support the fair value measurement of financial derivatives at least when not used as part of an effective hedge.

However, as regards certain aspects of hedge accounting, the treatment of liabilities repayable on demand and some other measurement issues, EFRAG members are divided:

• The assenting members (i.e. those supporting endorsement of IAS 39), while hoping that further improvement will be possible in the medium term to meet the concerns raised below, believe that IAS 39 now meets the requirements of the IAS Regulation. Accordingly, they favour endorsement of IAS 39.
• The dissenting members disagree with the requirements related to these issues, for reasons set out below in detail, and believe that IAS 39 in its present form does not meet the criteria of the IAS Regulation and therefore should not be endorsed.

• Extra disclosures to explain differences from IFRS, for reasons of transparency.
• Companies would no longer be able to claim that their financial statements were prepared under IFRS, with related consequences for the audit report.
• Related audit implications.
• The risk of setting a precedent.
• System changes implications of any unique European standards in any area, such as IAS 39.
• The risk that some financial institutions, banks or insurance undertakings that apply or want to apply IAS 39 will be seriously disadvantaged.
• Access to capital markets could be restricted or made more expensive.
• Loss of opportunity to converge IFRS and US GAAP and possible impact on other elements of transatlantic dialogue.

1. Whether the objectives of the IASC Foundation should expressly refer to the challenges facing SMEs The members believed that the issues of SMEs should be considered by the IASB, but questioned the inclusion of such a requirement in the constitution. The overall belief of the members was that if the constitution were to include such a reference, that reference should not be in the paragraph discussing rigorous application (as proposed). That is, regardless of the standards that apply to an entity, they should all be applied with rigour.

2. Number of trustees and their geographical and professional distribution The trustees have proposed equal representation from North America, Europe, and Asia/Oceana regions. Some members suggested that the constitution not include any specific criteria, but require the selection of the best people. Others argued that the regions that apply IFRS should be represented more than North America. Members were concerned that excluding North America would send a message that convergence was not important – which was not the belief of most members. That is, involvement in the process will create interest to "join the game".

Members also noted that the purpose of financial information is for users and, therefore, the regions with the most dominant capital markets should be equally represented. There was also a suggestion to add trustees with backgrounds as regulators to the requirements in the constitution.

The subcommittees briefly discussed how trustees were selected. The current IASCF Chairman expressed concern that the process was already burdensome and that adding more requirements seemed unnecessary. One member suggested appointing a nominating committee (without much support).

3. The oversight role of the Trustees The trustees had recommended that the constitution be amended to include a requirement to "carefully consider the IASB's agenda". The members expressed concern with understanding exactly what is meant by that phrase and asked the wording in the constitution to be expanded. The IASCF Chairman noted that the trustees would not have veto power over agenda items, but would require the IASB to review the agenda items with the trustees on a regular basis. The intention of the trustees was to require the IASB to bring a potential agenda item to the trustees for positive approval. It was also suggested that the trustees could require the IASB to add an item onto its agenda. There was general consensus that the Trustees role in relation to the agenda should not be strengthened to the point of approval, but should be just short of that line.

Some members expressed concern that the current IASB members do not consider the practical implementation issues related to its proposals. There was consensus that the trustees should monitor this issue actively with each project.

Several members strongly encouraged the trustees to reconsider whether it should undertake educational activities. There were questions over due process, the costs needed to build up the infrastructure, and the ability to have appropriate review by the trustees (since supposedly the IASB staff would not be used). The trustees were surprised by the level of concern and countered that if the trustees do not undertake these activities, interpretations around the world could differ. The members noted that there is nothing the trustees can do to prevent this – including issuing training materials. The staff noted that the IASB is currently developing 2-page summaries of its standards targeted to CFOs. One CFO at the table stated that he already gets those summaries from the Big 4 Firms – why does he need another one from the trustees?

4. Funding of the IASC Foundation The IASCF Chairman asked for any bright ideas on how to raise funding. The only alternative discussed was whether it was feasible to implement a fee-based structure with the exchanges. One member also suggested a nominal fee for all purchases of securities over a certain amount. The concern was that any of these suggestions would have to be implemented by changing local laws.

5. The composition of the IASB The Trustees recommended keeping 14 Board members, but allowing between 2 and 4 part-time members. There was general agreement with this approach as some noted that the part-time member from the accounting profession added significant quality and real life experience to the Board.

Some members expressed concern about the composition of the Board with 10 of 14 being "Anglos". In addition, six come from countries that don't apply IFRS. The majority of the members believe membership of the IASB should be based on competence and not nationality.

6. The appropriateness of the IASB's existing formal liaison relationships There was general support for maintaining the requirement in the constitution to have liaison relationships. There was support, however, for ensuring the constitution remains flexible to change as situations change. One European member suggested that EFRAG replace the European national standard setters in the liaison relationships. The IASCF Chairman noted this would make it much easier and was open to pursuing this suggestion.

7. Consultative arrangements of the IASB The trustees expressed concern with cluttering up the constitution with due process issues. There was a suggestion that field tests (as distinct from merely field visits) should be mandatory on all projects. While there was not general support for making field tests mandatory, there was general agreement that field tests should be used more often. Several members suggested the IASB must validate to the trustees why it did not use field tests.

Concern was raised that the current activities of the IASB do not consider the difficulties raised by users of IFRS having different language requirements. For example, 3 months is too short for a comment period as exposure drafts are not translated in time. The IASCF Chairman expressed concern about the cost of translation. There was general agreement that the cost of being an international organisation includes the cost of ensuring those companies applying IFRSs can fully understand IFRSs.

8. Voting procedures of the IASB The Trustees have proposed changing the voting requirements from a majority (8 members) to requiring the vote of 9 members. There was no objection to 9; however, one member suggested raising the requirement to 10. There was little support for this suggestion.

9. Resources and effectiveness of the International Financial Reporting Interpretations Committee (IFRIC) The members recognised there is concern over IFRIC, but were not sure there was anything that related to the constitution. One member raised the question of whether IFRIC interpretations should be exposed. The general belief around the table was that recent experience suggests exposure should continue to be required.

10. The composition, role, and effectiveness of the SAC The subcommittee of the SAC presented draft recommendations to the trustees in how to improve its process. There was general concern that SAC was not operating effectively, and therefore as a result, the IASB was not receiving advice in a useable manner. The reasons for this were various and include the size of SAC, the chairmanship of SAC, etc. The SAC members suggested the SAC develop a charter that would govern its activities and submit that charter to the trustees for approval.

There was general agreement with this approach. In addition, there was general agreement the chairman of SAC should not an IASB member, but should be a paid position for either a part-time or full time individual. This issue will be discussed at a future trustees meeting.

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