IASB and ASB of Japan in talks on convergence

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1 October November 2004 IASB and ASB of Japan in talks on convergence On 12 October the International Accounting Standards Board (IASB) and the Accounting Standards Board of Japan (ASBJ) announced that they had started talks about a joint project to minimise differences between International Financial Reporting Standards and Japanese accounting standards towards a final goal of convergence of their standards. Both boards believe that this effort is the first step in promoting further international convergence to high quality accounting standards and will contribute to the development of global capital markets. In the meeting held on 12 October, the IASB and the ASBJ discussed how to proceed with the joint project and agreed to launch the project as soon as possible. Sir David Tweedie, IASB Chairman, said: The objective of the IASB is to promote the use of a single set of high quality global IASB and FASB to develop single conceptual framework In October the IASB and the US FASB held another of their regular joint meetings. The two boards reached the far-reaching decision to add to their respective agendas a joint project to develop a common conceptual framework. The goal is a single framework that will not only secure the convergence of the existing frameworks the IASB s Framework for the Preparation and Presentation of Financial Statements and the FASB s Statements of Financial Accounting Concepts but improve on them. The project will be divided into phases. The initial focus will be on particular aspects of the frameworks dealing with objectives, qualitative characteristics, elements, recognition, and measurement. The boards will give priority to addressing issues that are likely to yield benefits to the boards in the short term, ie cross-cutting issues that affect a number of their projects for new or revised standards. standards. The decision of the ASBJ to join with us to examine the differences between our standards and, where the economic facts are similar, to discuss which of our two methods best reflects economic reality is a major boost for the convergence of accounting standards worldwide. I applaud the decision of the ASBJ to take this historic step. Professor Shizuki Saito, ASBJ Chairman, said: I believe that in developing global capital markets it is important that major accounting standard-setters around the world co-operate in reducing differences between standards as much as possible. We will work on the project from the perspectives of both co-ordination of domestic systems and the contribution to the establishment of an international order. The boards will focus first on concepts applicable to business entities in the private sector. Later, they will consider the applicability of those concepts to other sectors, beginning with not-for-profit entities in the private sector. The converged framework will be in the form of a single document, which will include a summary and a basis for conclusions. The boards plan to publish an initial communications document about the project, and their staff are already drafting that document. At the joint meeting in October, the staff proposed that the document should explain, amongst other things, the purpose and importance of the framework, why the boards wish their existing frameworks to converge, and why those frameworks are in need of improvement. INSIDE THIS ISSUE News 1-8 Project updates 9-18 Article Reports Appointments Staff changes 26 IASB Publications IASB INSIGHT / ISSN Editor: Michael Butcher The views expressed in IASB Insight are not necessarily shared by the IASC Foundation Trustees or the IASB. Articles are published without responsibility on the part of the publishers or the authors for loss occasioned by any person acting or refraining from acting as a result of any view expressed herein. Copyright 2004 International Accounting Standards Committee Foundation (IASCF). All rights reserved. No part of Insight may be translated, reprinted or reproduced or utilised in any form either in whole or in part or by any electronic, mechanical or other means, now known or hereafter invented, including photocopying and recording, or in any information storage and retrieval system, without prior permission in writing from the IASCF contact Gillian Bertol, Publications Director. IASB INSIGHT is published four times a year by the International Accounting Standards Committee Foundation, 30 Cannon Street, London EC4M 6XH, United Kingdom. Tel: +44 (0) Fax: +44 (0) iasb@iasb.org Web: To order IASB publications, visit our Website at

2 NEWS IASC Foundation to host XBRL conference The IASC Foundation is joining the XBRL International Consortium in hosting the 10 th XBRL International Conference, which is to be held on November in Brussels. The conference will be a showcase for the use of extensible Business Reporting Language (XBRL), a Web-enabling technology for better, faster and more cost-effective business reporting. The event will be the largest and most important electronic reporting conference since the XBRL technology was launched five years ago. The conference theme Financial reporting goes global: XBRL and IFRS working together focuses on XBRL implementations and the benefits of XBRL for anyone involved in compiling, analysing or transmitting financial information electronically. The IASC Foundation is a long-time supporter of XBRL as a tool for the electronic transfer of financial reporting information. XBRL is complementary to the Foundation s objectives of developing and promoting a single set of high quality, understandable and enforceable global accounting standards to help participants in the world s capital markets make economic decisions. The XBRL International Consortium has over 200 members, including some of the largest regulators, accounting and technology firms in the world. The conference will be opened by Kurt Ramin, Commercial Director of the IASC Foundation and Chair of XBRL International. He will introduce the keynote speakers, who will include Sir David Tweedie (IASB), Graham Ward (IFAC), Brigette Lippmann and Eric Schuppenhauer (US SEC), Jürgen Tiedje (European Commission), Stig Enevoldson (EFRAG) Pedro Diaz Muñoz (Statistical Office of the European Commission) and many more. The conference will provide the opportunity for delegates to learn about the approaches to adoption of XBRL by government and regulatory agencies around the world, including the SEC, the UK Financial Services Authority, Banco de España, Deutsche Börse AG, Centraal Bureau voor de Statistik, the US Federal Deposit Insurance Corporation, London Stock Exchange and EDGAR online. About XBRL extensible Business Reporting Language (XBRL) is a flexible medium, not dependent on any particular hardware or software, that allows corporate reporting information to be exchanged and disseminated via the Internet. It can be used to express a wide range of reports and disclosures including financial statements, internal management information, regulatory returns, statistical reports and credit filings. The availability of XBRL has been widely recognised as an important advance in the improvement of corporate transparency. Julie Erhardt appointed as SEC Deputy Chief Accountant On 15 October the Chairman of the US Securities and Exchange Commission, William H Donaldson, announced the appointment of Julie A Erhardt to serve as Deputy Chief Accountant. Ms Erhardt will report to Donald T Nicolaisen, Chief Accountant, and share responsibilities for the day-to-day operations of the Office of the Chief Accountant with Scott Taub and Andrew Bailey. These responsibilities include resolution of accounting and auditing issues, rule-making projects, and oversight of private sector standard-setting efforts and the regulation of auditors. Ms Erhardt will work closely with various international organisations including the IASB and the International Federation of Accountants on issues relating to convergence of accounting, auditing and reporting standards. Commenting on the appointment Mr Nicolaisen said, I am delighted that Julie has agreed to join the Commission. Having a person of her experience, intelligence and enthusiasm will contribute significantly to improvement in accounting and auditing standards and practices worldwide and to the Commission s efforts to encourage convergence in these important areas. I m confident that Julie s work will greatly benefit the Commission and the investing public. Ms Erhardt spent the past year as a Sloan Fellow at the Graduate School of Business at Stanford University, where she received a Master s Degree in management. Before that, she spent seven months on an interim assignment with the IASB in London, where she contributed to the Improvements project, notably on IAS 16 Property, Plant and Equipment. Most of her previous career was spent at Arthur Andersen LLP where she was admitted as a partner in She also served a two-year fellowship at the US Financial Accounting Standards Board. 2 IASB INSIGHT, October November 2004

3 NEWS IASB announces membership of two advisory working groups On 21 September the IASB announced the membership of two advisory working groups, on financial instruments and on insurance. An announcement is expected soon on a third working group, on performance reporting. The background to the establishment of these groups was described in the Chairman s page of the July edition of Insight. In May 2004, the IASB posted a notice on its Website inviting nominations for the working groups. It also wrote to various organisations to draw attention to the notice. IASB members and staff prepared initial proposals for the working groups membership, which were reviewed by the Trustees of the IASC Foundation, amended in the light of their comments and approved by them. Working group on financial instruments The working group has been formed to help the IASB to analyse accounting issues relating to financial instruments. The group brings together a wide range of interests and includes senior financial executives who are involved in financial reporting. Details of the members and observers are given below. The financial instruments working group will help the IASB take a fresh look at the accounting standard IAS 39 Financial Instruments: Recognition and Measurement by examining and questioning the fundamentals of the standard within the context of the IASB s Framework. The review will therefore focus on improving, simplifying and ultimately replacing IAS 39 and will examine broader questions of the application and extent of fair value accounting a topic on which the IASB has not reached any conclusion. Although any major revision of IAS 39 may take several years to complete, the IASB is willing to revise the standard in the short term if any immediate solutions emerge from the working group s discussions. Membership of the financial instruments working group Name Title Organisation Country Melissa Allen European Head of New Business and Technical Credit Suisse United Kingdom Accounting Support First Boston Jeannot Blanchet Managing Director Equity Research Morgan Stanley France Joseph Boateng Manager, Pension Funds Johnson & Johnson United States Philippe Bordenave Group Chief Financial Officer BNP France Gunther Gebhardt Professor Johann Wolfgang Germany Goethe University Mark Kirkland Vice President, Corporate Treasury Philips The Netherlands François Masquelier Head of Corporate Finance and Treasury RTL France Esther Mills First Vice President, Head of Accounting Policy Merrill Lynch United States Ralph Odermatt Managing Director, UBS Switzerland Head of Group Accounting Policies and Support Russell Picot Group Chief Accounting Officer HSBC United Kingdom Francis Ruijgt ING Group Corporate Insurance Risk Management, Deputy Chief Insurance Risk Officer International Actuarial Association/ING Group The Netherlands Yoshio Sato Partner in Financial Industries Group Deloitte Japan Elisabeth Schmalfuss Head of Accounting and Controlling Policies Siemens Germany Sadaki Takagi Senior Director for Bank Accounting Japanese Bankers Japan Association Bob Uhl Partner Deloitte United States Pauline Wallace Partner in IFRS Services PwC United Kingdom Peter Zegger Corporate Centre Controller Unilever The Netherlands Observers Basel Committee on Banking Supervision European Central Bank European Financial Reporting Advisory Group International Organization of Securities Commissions Also participating: Staff of the US Financial Accounting Standards Board IASB INSIGHT, October November

4 NEWS Working group on insurance The working group has been formed to help the IASB analyse accounting issues relating to insurance contracts. The group brings together a wide range of interests and includes senior financial executives who are involved in financial reporting. Details of the members and observers are given below. The insurance working group will help the IASB take a fresh look at financial reporting by insurers. Although the IASB s predecessor (IASC) produced an Issues Paper and a Draft Statement of Principles, and the IASB itself has discussed the project at many Board meetings, other priorities forced the IASB to suspend work following the January 2003 meeting. Therefore, the IASB will regard the past work as a useful resource, but will not feel bound by it. The only restrictions on a fresh look are the IASB s Framework and the general principles established in the IASB s existing standards. Membership of the insurance working group Name Title Organisation Country Phil Arthur Partner Ernst & Young Canada Norbert Barth Associate Director, DZ Bank AG Germany Senior Analyst, Equity Research Philip Broadley Chief Financial Officer Prudential United Kingdom Tony Coleman Chief Risk Officer and Chief Actuary Insurance Australia Group Australia Denis Duverne Chief Financial Officer Axa France Sam Gutterman Chair of Insurance Accounting Committee International Actuarial Association * International/ United States Rob Jones Managing Director Standard & Poors United Kingdom Marc Meiches Chief Financial Officer Employers Reinsurance United States Company Patrick O Sullivan Chief Financial Officer Zurich Financial Services Switzerland Hitesh Patel Partner KPMG United Kingdom Helmut Perlet Chief Financial Officer Allianz Germany Jörg Schneider Chief Financial Officer Munich Re Germany Howard Smith Chief Financial Officer American International Group United States Jerry de St Paer Chief Financial Officer XL Capital Bermuda Joseph Streppel Chief Financial Officer Aegon The Netherlands Mark Swallow Chief Accounting Officer Swiss Re Switzerland Yoshikazu Takeda Director and General Manager Nippon Life Japan Hiroyuki Yamaguchi General Manager Sompo Japan Insurance Japan Alan Zimmerman Independent security analyst GA Zimmerman associates United States Observers International Organization of Securities Commissions International Association of Insurance Supervisors Basel Committee on Banking Supervision European Financial Reporting Advisory Group Also participating: Staff of the US Financial Accounting Standards Board * Mr Gutterman is also a Director and Consulting Actuary with PricewaterhouseCoopers in the US. Mr O Sullivan was appointed in October 2004 to replace Mr Raffaele Agrusti (Generali, Italy), who resigned on assuming new responsibilities. 4 IASB INSIGHT, October November 2004

5 NEWS IASB Chairman in Brussels On 22 September the Chairman of the IASB, Sir David Tweedie, appeared before the Committee on Economic and Monetary Affairs of the European Parliament, in Brussels. His written evidence was as follows: Mme Chairwoman and Members of the Committee: My colleagues and I welcome this opportunity to meet the Committee to discuss the latest work of the International Accounting Standards Board (IASB) on IAS 39, the accounting standard on financial instruments. It is my hope that this meeting will lead to regular contact between the Committee and the IASB. (For reference purposes, I have attached, as Appendix A [not reprinted here], a brief outline of the structure and history of the IASB and its oversight body.) The Committee asked the IASB to appear to discuss progress with IAS 39 and the proposals of the European Commission. In this statement, I shall focus on IAS 39, because the IASB has not taken a position on the proposals for endorsement. But I should emphasise at the outset that full endorsement of all of the IASB s standards, including IAS 39, is our preferred option. Although we are aware of the challenges that endorsement would pose, we are concerned that piecemeal approval of any of the IASB s standards risks undermining the coherence and integrity of the standards and making them more difficult to apply consistently. Background on IAS 39 Over the past three years, the IASB has heard many criticisms used to argue against the endorsement of IAS 39. We have listened carefully to suggestions and we have made adjustments to the standard, where feasible. Before discussing the changes that we have made, I should like to comment on two common criticisms first, that IAS 39 is too complex and prescriptive (and thus flawed), and second, that the standard, both as originally issued by our predecessor, IASC, and as modified by the IASB, is the result of inadequate consultation and due process. IAS 39: Bridging two accounting models It is true that IAS 39 is a complex standard, but the complexity results from an attempt to bridge the worlds of traditional cost-based accrual accounting and a system that is more reliant on market values. The resulting combination of methodologies is what accountants call a mixed attribute model. Undoubtedly, a standard that was based solely on cost or on market values would provide simplicity, but neither solution would be satisfactory either in attracting broad support or in providing sufficient transparency for the investing public. When it comes to derivatives, cost accounting is inappropriate, because the cost of derivatives is generally zero, while the potential exposure and risk to a company s financial position can be huge. Large losses can be obscured from both management and investors until the point of realisation. We have seen several cases in Europe (eg, Metallgesellschaft and Barings) and in the United States (eg, Orange County) where the use of derivatives has caused the collapse of seemingly financially stable entities. At the same time, few would accept marking all financial instruments to market and requiring gains and losses to be shown in the income statement. Therefore, we are at present bound to a mixed model, such as IAS 39 or the similar standards that apply in Canada, Japan, or the United States. In this mixed attribute model, IAS 39 allows similar financial instruments to be accounted for differently depending on management s designation or its stated or intended use of the instruments. Its use of alternative accounting methods necessitates detailed rules to limit the extent to which management can defer losses and manage earnings by the selective recognition of gains and losses and compromises our primary objective of providing principle-based accounting standards. IAS 39: A carefully crafted approach Some commentators and constituents have noted that the IASB has called for a replacement for IAS 39, in an effort to reduce the complexity of the accounting rules for financial instruments. In that light, those commentators have called for the implementation of IAS 39 to be postponed until a better alternative could be found. I believe that finding such a replacement will not be easy and will probably take a long time a luxury that we did not have in preparation for the adoption of international standards in the European Union. In the absence of an alternative that would provide sufficient transparency, IAS 39 already tested in the marketplace remained the best option. Indeed, the existing standard is the result of work begun by our predecessor, IASC, in 1988, and has been subject to several rounds of public consultation and input. After years of deliberation, and the publication of a discussion paper and a subsequent exposure draft, IASC finalised the original IAS 39 in 1998, and companies in Europe and elsewhere have been using the standard since then. A more detailed summary of the due process on IAS 39 is in Appendix B. When the IASB was formed in 2001, we decided to give priority to addressing some of the implementation problems identified by existing users of IAS 39 in an effort to have an improved standard ready for European companies by It was the process of consultation initiated by our proposed improvements that provided the opportunity for concerns expressed most notably by the European banking community to come to light. Responding to constituents concerns The 170 comment letters received in response to our initial proposed improvements to IAS 39, published in June 2002, indicated a desire on the part of many respondents for the IASB to broaden its examination of the standard. We did so after holding a full week of public round-table discussions with more than 100 organisations in Brussels and London in March As a result of the round-tables and other discussions over the following months and our analysis of comment letters, the IASB made numerous changes to the exposure draft before issuing the revised standard in December The IASB has continued to work on five remaining areas of concern to IASB INSIGHT, October November

6 NEWS constituents, particularly among the banking community. These areas included: 1. Macro hedging for banks 2. Mismatch of insurance companies assets and liabilities resulting from IAS Accounting for shares in co-operative entities 4. Fair value option 5. Hedge accounting for banks I am happy to report that through consultation and collaboration with the affected parties the IASB was able to reach a conclusion on the first three issues that preserved the principles of IAS 39, but addressed the concerns of industry. In March this year the IASB issued an amendment to IAS 39 that permits a form of macro hedging. The IASB worked with the insurance industry to mitigate the problems that might arise from differing valuation techniques of assets and liabilities. Lastly, the IASB s interpretative body, the International Financial Reporting Interpretations Committee (IFRIC), is finalising an interpretation that clarifies the treatment of members shares. The discussion that is continuing, both at the IASB and with the European Commission, relates to the last two issues, on which I comment in more detail below. Fair value option In response to criticisms about the complexity of the requirements of IAS 39 and the possible introduction of unnecessary accounting volatility in the financial statements, the IASB included a provision to its improved IAS 39 to enable any financial instrument, subject to certain limitations, to be carried at fair value with changes in fair value recognised in profit or loss. The standard allows the fair value measurement of financial instruments on the basis of management s designation of them for that purpose, but to protect against manipulation the IASB limited the use of the fair value option by requiring the fair value designation to be made at the point when the derivative was acquired. Once the designation is made, it cannot be withdrawn throughout the life of the instrument. In response to concerns expressed by banking supervisors and the European Central Bank, the IASB published an exposure draft of an amendment to limit further the circumstances in which an instrument could be designated for fair value measurement. Generally, banking supervisors were concerned that the designation for fair value measurement could be used to inflate earnings; they also commented that it did not make sense to recognise gains from a decline in the fair value of liabilities resulting from credit deterioration. They were also concerned that the designation might be another step toward the comprehensive use of fair value measurement for financial instruments. Our intention was not to signal a commitment to move to a full fair value model, but to provide a means of reducing compliance costs. We have only just received the responses on the proposal to restrict the option and will begin to redeliberate the issues associated with the fair value option this week. The large majority of responses to the exposure draft do not support the proposed tighter restrictions on the grounds that the proposal is excessively complex, would be difficult to make operational, and might reduce the benefits originally envisaged when the original option was introduced into the standard. At the same time, discussions with banking supervisors indicate that their concerns continue. The IASB recognises that it must bring this matter to a resolution as soon as possible if some form of the fair value option is to be available to first-time adopters in Europe. (The Australian Accounting Standards Board has approved the use of the existing option for Australian companies.) Therefore, we will seek to arrange meetings between representatives of the IASB and interested parties, including the ECB and the Basel Committee, so that we can all exchange views in order to understand the various concerns, with a view to trying to find a solution. Hedge accounting for banks As mentioned above, a particular area of contention in IAS 39 is hedge accounting related to banks. In the absence of IAS 39, the banks prevalent practice was to account for derivatives used for risk management purposes on an accrual basis of accounting. The IAS 39 requirement to account for derivative financial instruments at fair value introduces volatility in profit and loss when the fair values of the derivatives change. However, to the extent that the derivatives are used in a qualifying hedging relationship and are effective in offsetting risk, changes in their fair values do not create volatility in profit and loss under IAS 39. This is because they are either offset in profit and loss with the changes in the fair value of the items being hedged or they are recognised in equity when the hedged items consist of expected future cash flows that will provide the requisite offset in future periods. The IASB understands that the hedge accounting provisions are not aligned with the way in which banks manage their interest rate risk, the objective of which is to reduce the variability of their accrual basis net interest income (margin). The IASB also understands that banks want more flexibility in measuring the effectiveness of hedging relationships so that the changes in the fair value of derivatives used to reduce the variability of their net interest margin do not create volatility in the financial statements. The IASB is seeking a solution that is consistent with the principles it has identified that relate primarily to hedge accounting, namely, that derivatives should be measured at fair value; all material hedge ineffectiveness should be identified and recognised immediately in profit or loss; and only items that are assets and liabilities should be presented as such in the balance sheet. Deferred losses are not assets and deferred gains are not liabilities. However, if an asset or liability is hedged, any change in its fair value that is attributable to the hedged risk should be presented in the balance sheet. However, identifying a satisfactory solution consistent with these principles is difficult. To align hedge accounting with risk management practices would require that such practices be made uniform so that the accomplishment of the objective can serve as a basis for accounting. Banks, however, manage interest rate risk differently and there is no standard or convention for assessing whether a bank s objective of 6 IASB INSIGHT, October November 2004

7 NEWS reducing the variability of its net interest margin is in fact being accomplished. Also, fair value accounting used for derivatives is incongruent with the accrual basis of accounting when it is used for assessing interest rate risk management activities. The effectiveness of a hedging relationship cannot be assessed appropriately unless both the derivative hedging activities and interest rate risk management activities are evaluated on the same basis, either on a fair value basis or on a cash flow basis. Also, the IASB is concerned about compromising the effectiveness requirements of IAS 39. Introducing flexibility to effectiveness measurement would defeat the purpose of requiring derivative financial instruments to be carried at fair value and would introduce an undisciplined accounting alternative that could obfuscate in the financial statements the true nature of derivatives activities. Representatives of the IASB have been working with representatives of the European Banking Federation (FBE) for more than a year to develop improvements to IAS 39. Those meetings resulted in the new hedge accounting solution contained in the amendment issued as Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk. Although the FBE encouraged the IASB to issue this amendment, it also proposed, a few weeks before its publication in March 2004, that another hedge accounting proposal should be considered by the IASB for adoption in addition to the amendment. Representatives of the IASB have held several meetings with representatives of the FBE to discuss and develop this proposal, which is referred to as the interest margin hedging proposal. At each meeting the IASB representatives have raised important concerns about the proposal, including the ability it would give management to identify a non-existent exposure as a hedged risk. The major concerns were set out in a letter sent to representatives of the FBE on 25 August, and copied to the Commission. The letter asked the FBE to respond to each of these concerns at the next meeting of the IASB and FBE representatives scheduled for later this month. The IASB intends to continue to work with representatives of the FBE to search for a better hedge accounting solution, but it does not believe that the present interest margin hedging proposal is a viable alternative unless major changes can be made to it. Banks have also expressed concern about the volatility shown in equity under IAS 39 resulting from cash flow hedge accounting. In response to this concern, representatives of the IASB and the FBE have met several times and have corresponded to explore alternatives for presenting cash flow hedge accounting results in equity to better communicate the related risk management activities. We also have explored various footnote disclosure possibilities to describe these activities more fully. We continue to work on the presentation and disclosure possibilities. Where do we go from here? The IASB wants to find a better accounting solution for financial instruments that will produce meaningful results without undue complexity and dependence on detailed rules, but experience shows that an ideal solution will take several years to develop. During the past two years, the IASB has engaged in numerous meetings with constituents to understand better their concerns and to listen to their suggestions for improvements. In response, it has already made changes and has published proposed changes to IAS 39 for public comment to improve the standard in the short term. The IASB has also established a financial instruments working group with the objective of continuing to improve IAS 39 on an ad hoc basis while working toward an ideal solution. The first meeting of that group is scheduled to take place at the end of this month. The IASB understands the concerns relating to IAS 39, particularly about its complexity, but believes that until a better solution can be identified and developed the discipline required by the provisions of IAS 39 is essential to provide credibility to financial statements prepared under International Financial Reporting Standards and to the development of a common European capital market. * * * * * Appendix B IAS 39 Due Process Accounting for financial instruments is a difficult and controversial subject. The International Accounting Standards Board s predecessor body, the International Accounting Standards Committee (IASC), began its work on the issue some 16 years ago in During the next eight years it published two exposure drafts, culminating in the issue of IAS 32 Financial Instruments: Disclosure and Presentation in IASC decided that its initial proposals on recognition and measurement should not be progressed to a standard, in view of the critical response they had attracted, evolving practices in financial instruments and the developing thinking by certain national standard-setters. In the meantime, IASC concluded that a standard on the recognition and measurement of financial instruments was needed urgently. It noted that although financial instruments were widely held and used throughout the world, few countries apart from the United States had any recognition and measurement standards for them. In addition, IASC had agreed with the International Organization of Securities Commissions (IOSCO) that it would develop a set of core International Accounting Standards that could be endorsed by IOSCO for the purposes of cross-border capital raising and listing in all global markets. Those core standards included one on the recognition and measurement of financial instruments. In March 1997, IASC, jointly with the Canadian Institute of Chartered Accountants, published a comprehensive Discussion Paper Accounting for Financial Assets and Financial Liabilities and invited comments on its proposals. IASC held a series of special consultative meetings about those proposals with various national and international interest groups and in numerous countries. Those meetings and analysis of comment letters on the Discussion Paper confirmed that IASC faced controversies and complexities in seeking a way forward. While some acceptance existed of the view put forward in the Discussion Paper that measurement of all financial assets and liabilities at fair IASB INSIGHT, October November

8 NEWS value was necessary to obtain consistency and relevance to users application of that concept to some industries and to some kinds of financial assets and liabilities continued to present difficulties. Concerns focused on reliability, volatility, and the presentation of the effects of changes in values issues that still exist. Widespread unease was also evident about the prospect of including unrealised gains, particularly on long-term debt, in income as proposed in the Discussion Paper. Furthermore, although several national standard-setters had undertaken projects to develop national standards on various aspects of recognition and measurement of financial instruments, no country had in place or proposed standards that were similar to the proposals in the Discussion Paper. Completion of a single comprehensive International Accounting Standard on financial instruments based on the Discussion Paper for inclusion, before the end of 1998, in the core standards to be considered by IOSCO was not a realistic possibility. Nonetheless, the ability to use International Accounting Standards for investment and credit decisions and securities offerings and listings was urgent for both investors and business enterprises. Accordingly, in 1997 IASC decided: (a) to join with nine national standard-setters to form a Joint Working Group (JWG) to develop the proposals in the 1997 discussion paper. The ultimate aim was an integrated and harmonised standard on financial instruments that would reflect the best research and thinking on the subject worldwide. IASC recognised that this would take several years to develop. The JWG took the first step in the form of a draft standard published in 2000, before the IASB had been constituted. (b) at the same time, to develop an International Accounting Standard on the recognition and measurement of financial instruments that would serve until an integrated comprehensive standard was completed. This standard would be based on US GAAP the only major GAAP with comprehensive requirements for financial instruments. The result was IAS 39 Financial Instruments: Recognition and Measurement, issued in 1999 after a period of exposure and comment. In August 2001 the International Accounting Standards Board (IASB) announced, as part of its initial agenda, that it would undertake a project to improve IASs 32 and 39 to simplify their application and implementation. The IASB invited the IAS 39 Implementation Guidance Committee (IGC) to function as an Advisory Committee to the Board in identifying and reviewing issues that should be addressed. The IGC consisted of senior experts in financial instruments with backgrounds as accounting standard-setters, auditors, bankers and preparers from a range of countries as well as observers from the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSCO) and the European Commission. In June 2002 the IASB published an exposure draft of proposed improvements to IASs 32 and 39. In response the IASB received over 170 comment letters. In view of this response, the IASB decided to extend the consultation by conducting a series of public round-table discussions with constituents. Round-tables are not a routine part of the IASB s due process, but are used when they would assist the development of a standard. The IASB decided to use the round-table format to allow a free and open exchange of views between the IASB and respondents and among respondents who might hold differing views. The IASB s ultimate goal was to determine whether there were better alternative applications of the principles underlying IASs 32 and 39, or whether these existing applications could be simplified. Because of time constraints imposed by the 2005 adoption in some jurisdictions, the IASB did not have sufficient time to reassess the fundamental principles behind existing practices. The round-table participants included 108 of the over 170 individuals, companies, regulatory bodies and other organisations that had commented on the exposure drafts of proposed amendments to IASs 32 and 39. After the round-table discussions the IASB began the process of public discussions by reviewing the round-table material with its Standards Advisory Council and with its partner national standard-setters. In March 2003 the IASB began its deliberations, in open Board meetings, of the issues raised on the Exposure Draft, keeping in view the insights obtained from the consultation process. There was one issue that had emerged from the consultation process which the Board decided warranted further debate. Many constituents, particularly in the banking industry, expressed concern that portfolio hedging strategies that they regarded as effective hedges would not qualify for fair value hedge accounting under IAS 39. In the light of these concerns, the IASB launched intensive discussions with the banking industry, represented by the European Banking Federation (FBE) to see if a way could be found within the principles of IAS 39 to accommodate macro hedging. As a result, in August 2003 the IASB published a second exposure draft, Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk, on this one aspect of IAS 39, proposing an important advance by permitting macro hedging. More than 120 comment letters were received. However, in order to help those companies preparing to adopt the revised IASs 32 and 39 in 2005, the IASB decided not to delay the finalisation of the rest of those standards for this one issue. Accordingly, the IASB issued the revised standards, subject to any amendments it might make for macro hedging, in December In March 2004 the IASB finalised the proposal to permit macro hedging and issued the amendment. In April 2004, the IASB published an exposure draft of a proposed limited amendment to IAS 39, The Fair Value Option. This proposal was a direct response to concerns expressed by prudential supervisors of banks, securities companies and insurers that the fair value option might be used inappropriately. The exposure draft proposed to limit the financial assets and financial liabilities to which the option may be applied, while preserving the key benefits of the option. The IASB is now considering the comment letters received on this proposal. 8 IASB INSIGHT, October November 2004

9 PROJECT UPDATE IASB project timetable (2004 and 2005) The chart below shows the IASB s present expectations about the timing of projects on its active agenda. Like all such projections, the timing of individual projects is subject to change as the IASB s deliberations proceed. As projects are completed, the IASB expects to add new projects including, potentially, those listed on the Website as other topics. For projects on the IFRIC s agenda, see page Qtr 4 Qtr 1 Qtr 2 later IAS 39 Financial instruments fair value option IFRS IAS 39 Financial instruments transition and initial recognition of financial assets and financial liabilities IFRS IAS 39 Financial instruments cash flow hedge accounting of forecast intragroup transactions IFRS IAS 39 and IFRS 4 financial guarantee contracts and credit insurance IFRS Financial instruments: disclosures IAS 32 Financial instruments shares puttable at fair value IFRS ED Business combinations phase II Application of the purchase method Minority interests amendment to IAS 27 ED ED Reporting comprehensive income DP Exploration for and evaluation of mineral resources IFRS Measurement objectives DP Revenue and related liabilities Intangible assets Management commentary Consolidation (including special purpose entities) phase I Insurance contracts phase II Extractive activities DP DP DP ED tbd tbd Short-term convergence of International Financial Reporting Standards and US accounting standards joint project with the FASB IAS 37 Provisions, Contingent Liabilities and Contingent Assets ED IAS 12 Income Taxes ED Other convergence projects IAS 19 Employee Benefits IFRS Amendment of IAS 20 (Government Grants etc) ED Accounting Standards for small and medium-sized entities ED Legend: DP - Discussion Paper ED - Exposure Draft IFRS - International Financial Reporting Standard (IFRSs include International Accounting Standards and Interpretations) tbd - to be decided IASB INSIGHT, October November

10 PROJECT UPDATE Financial instruments: easing the implementation of IAS 32 and IAS 39 Assistant project manager Andrea Pryde reports. Over the past few months the IASB has proposed various ways of easing the implementation of its standards on financial instruments. In July, in response to particular concerns raised by constituents, the IASB published three short exposure drafts of amendments to IAS 39 Financial Instruments: Recognition and Measurement: Transition and Initial Recognition of Financial Assets and Financial Liabilities Cash Flow Hedge Accounting of Forecast Intragroup Transactions Financial Guarantee Contracts and Credit Insurance The comment periods for these exposure drafts expired in October. The IASB intends to finalise the amendments as soon as possible, and in particular to issue any amendment on transition before the end of 2004 for application for annual periods beginning on or after 1 January The other two amendments would be effective for annual periods beginning on or after 1 January 2006, but earlier application would be permitted (for the cash flow hedge accounting amendment) or encouraged (for the amendment on financial guarantees and credit insurance). Also in July the IASB published exposure draft ED 7 Financial Instruments: Disclosures. This document proposed a complete IFRS to replace IAS 30 Disclosures in the Financial Statements and Similar Financial Institutions and the disclosure requirements in IAS 32 Financial Instruments: Disclosure and Presentation. In doing so, it proposed to remove disclosure requirements that are regarded as too onerous and to simplify others. Although ED 7 proposed that the standard should be applied from January 2007, the IASB is aware that many constituents are keen to adopt the proposed standard early. It therefore hopes to complete its consideration of the comments received in time to allow the IFRS to be issued around the middle of next year. It would be effective for annual periods beginning on or after 1 January 2007, but earlier application would be encouraged. Earlier this year the IASB published an exposure draft of other amendments to IAS 39 The Fair Value Option. The proposal was to restrict the use of the fair value option by limiting the financial assets and financial liabilities to which the option may be applied, while preserving the main benefits of the option. The exposure draft was published in direct response to concerns that the fair value option in IAS 39 might be used inappropriately. At its meeting in September, the IASB had a preliminary discussion of the 115 comment letters received on this exposure draft. It noted that the majority of respondents did not agree with the proposals in the exposure draft, including a majority of all categories with the exception of regulators. Most respondents favoured retaining the unrestricted fair value option in IAS 39 (as revised in March 2004). However, the IASB noted that this would not address the concerns of regulators that were the reason for issuing the exposure draft. The IASB therefore agreed to explore various possibilities for obtaining additional input on possible courses of action. The IASB s aim is to establish whether there is a solution that would be acceptable to all parties the IASB, its constituents and regulators. Separately from these exposure drafts, the IASB has agreed to consider concerns raised by constituents about the classification as liabilities or equity of members shares in co-operatives. The IASB referred the matter to the IFRIC, which released a draft Interpretation, D8 Members Shares in Co-operative Entities, in June. In October the IFRIC considered the 96 comment letters that had been received and it confirmed the general approach proposed in D8. After considering some outstanding issues the IFRIC completed its Interpretation at its meeting in November (see page 17). The IASB has also tentatively agreed to explore whether financial instruments that allow the holder to put those instruments to the issuer for a pro rata share of the fair value of the residual interest in the issuer should be exempted from the general requirements of IAS 32 and classified as equity. The IASB has been continuing its discussions with the European Banking Federation (FBE) on matters of concern to the FBE. The discussions have focused on the presentation of cash flow hedges, and on a proposal put forward by the FBE for a new type of hedge accounting for hedges of interest rate margin. As foreshadowed in an announcement in March 2004, the IASB has established a working group to assist in improving, simplifying and ultimately replacing IAS 39 and to examine broader questions regarding the application and extent of fair value accounting (see page 3). The first meeting of the working group was held on 30 September and 1 October, when it had a preliminary discussion of issues that are likely to have priority in setting its agenda. Although any major revision of IAS 39 may take several years to complete, the IASB is willing to revise the IAS in the short term in the light of any immediate solutions arising from the working group s discussions. 10 IASB INSIGHT, October November 2004

11 PROJECT UPDATE Convergence: progress on short-term project with the FASB Work on the short-term convergence project with the FASB continues, with the IASB focusing on: convergence with the US standard SFAS 146 Accounting for Costs Associated with Exit or Disposal Activities (see next article, on amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets) and convergence between IAS 12 Income Taxes and SFAS 109 Accounting for Income Taxes. In relation to income taxes, the IASB has now made initial tentative decisions on proposals on almost all the differences between IAS 12 and SFAS 109. The issues it has still to consider include intraperiod allocation (including backwards tracing of amounts relating to items recognised in equity) and disclosures. The IASB has also had joint discussions with the FASB on the exemption from recognising deferred tax on temporary differences arising from unremitted earnings of foreign subsidiaries. The tentative decision of both boards was that the existing exemption in SFAS 109 should remain and the existing broader exemption in IAS 12 which covers domestic and foreign subsidiaries should be amended to converge with SFAS 109. The FASB will consider the IASB tentative decisions on the other issues over the next six months with a view to publishing convergent proposals in The FASB is considering the comments received on the four convergence exposure drafts that it published earlier in 2004 on: voluntary changes in accounting policies earnings per share asset exchanges and the treatment of idle capacity and spoilage costs in the cost of inventory The FASB expects to issue final amendments on these issues by the end of In the next phase of the short-term project with the FASB, the boards plan to work together on the following: research and development, interim reporting, segment reporting, impairment (after the measurement research project), borrowing costs (after the measurement research project), joint ventures, investment properties, and property, plant and equipment. Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets The proposed amendments to IAS 37 arise from two of the IASB s projects: the Short-term Convergence project and the second phase of the Business Combinations project. Project manager Henry Rees reports. Short-term Convergence As reported in the April/May edition of Insight, the objective of the proposed amendments arising from the Short-term Convergence project is to eliminate, as far as possible, the differences in the recognition of provisions for restructuring costs under IAS 37 and SFAS 146 Accounting for Costs Associated with Exit or Disposal Activities. As a result of amending the requirements relating to restructuring costs in IAS 37, the IASB will also amend the requirements relating to termination benefits in IAS 19 Employee Benefits. Business Combinations phase II Most of the remaining proposed amendments to IAS 37 reflect decisions in the second phase of the Business Combinations project relating to the treatment in a business combination of contingencies of an acquiree. As a result, the IASB has modified the definition of a contingent asset to a conditional right and the definition of a contingent liability to a conditional obligation. Accordingly, a contingent asset (or contingent liability) by itself does not satisfy the definition of an asset (or a liability). This is because the right (or obligation) is conditional on the occurrence (or non-occurrence) of an uncertain future event and hence is not a present right (or obligation). However, a contingent asset (or contingent liability) is sometimes accompanied by an unconditional right (or unconditional obligation) that satisfies the definition of an asset (or a liability). An example of a contingent liability (conditional obligation) that is accompanied by an unconditional obligation is a guarantee contract. In this example, the issuer of the guarantee has two obligations: a conditional obligation to make a payment under the guarantee if a specified triggering event occurs and an unconditional obligation to stand ready to honour the guarantee for the duration of the contract. The IASB therefore proposes that an entity should account for the asset stemming from the unconditional right in accordance with either IAS 38 Intangible Assets or IAS 39 Financial Instruments: Recognition and Measurement, depending on the nature of the asset, and account for the liability stemming from the unconditional obligation in accordance with either IAS 37 or IAS 39. Probability recognition criterion As a result of revising the definition of a contingent asset and a contingent liability, the IASB revisited the application of the probability recognition criterion in IAS 37 (paragraph 14(b)). IASB INSIGHT, October November

12 PROJECT UPDATE This criterion is derived from paragraph 83 of the Framework. Under the Framework, the function of the criterion is not to determine whether an entity has a liability, but whether it is probable that settlement of an item that satisfies the definition of a liability will require an outflow of economic resources. The IASB concluded that it was particularly important to apply the criterion to the unconditional obligation (liability) rather than to any conditional obligation (contingent liability) associated with that liability. So, for example, in the case of a guarantee, the criterion is applied to the unconditional obligation to stand ready to honour the guarantee rather than the conditional obligation to make a payment under the guarantee. Similarly, in the case of a lawsuit, the criterion is applied to the unconditional obligation to stand ready to accept the decision of the court, rather than the conditional obligation to pay damages. The Framework describes the probability recognition criterion in terms of an outflow of economic resources (not just cash flows). This includes the provision of services. Therefore the IASB reasoned that, for example in the case of a guarantee, the probability criterion is satisfied because it is certain that the obligation will require an outflow of economic resources (ie the stand-ready service). Similarly, in the case of a lawsuit, the probability criterion is satisfied because it is certain that the entity is standing ready to accept the decision of the courts. The IASB decided that the clearest way of reinforcing this interpretation of the probability recognition criterion would be to omit the criterion from the amended IAS 37, on the grounds that it will always be met and is therefore unnecessary. Consequently, an item that satisfies the definition of a provision would be recognised, unless its amount cannot be measured reliably. Timetable Given the relationship with the second phase of the Business Combinations project, the IASB decided that the exposure draft of amendments to IAS 37 should be published at the same time as the exposure draft of amendments to IFRS 3 Business Combinations. Business Combinations phase II Project manager Galina Ryltsova reports. Phase II of the Business Combinations project includes a joint project with the US FASB on purchase method procedures. An important objective of the joint project is the convergence of FASB and IASB guidance on accounting for business combinations. The July 2004 edition of Insight reported the IASB s tentative conclusion that the exposure draft arising from the joint project should propose that business combinations involving two or more mutual entities or business combinations in which separate entities are brought together by contract alone (combinations by contract) should be accounted for in accordance with the proposals in the joint project. The IASB also decided to consider in September-October 2004, before publishing the exposure draft, the issues that might arise from applying the decisions in the Purchase Method Procedures project to such business combinations. In considering these issues the IASB also took into consideration the views expressed in the 75 comment letters it received on its exposure draft of Proposed Amendments to IFRS 3 Business Combinations Combinations by Contract Alone or Involving Mutual Entities. The IASB reaffirmed its earlier tentative decision to include such business combinations in the scope of the Purchase Method Procedures exposure draft. The IASB observed that business combinations by contract or involving two or more mutual entities have many important characteristics that are similar to those business combinations involving other business entities. It also noted that such combinations have certain characteristics that distinguish them from combinations of other business entities (these were discussed in the July 2004 edition of Insight), but concluded that there are no unique circumstances for combinations of mutual entities or by contract that would justify a different accounting for those combinations. The IASB agreed that in a business combination by contract or involving two or more mutual entities: the purchase method of accounting should be applied; possible difficulties in identifying the acquirer are not a sufficient reason to justify a different accounting treatment and that no further guidance is necessary for identifying the acquirer for such combinations; the total amount to be recognised by the acquirer at the acquisition date should be the fair value of the business acquired; the accounting for goodwill should be the same as for combinations of other business entities; the credit side of the entry should be recognised directly in equity to the extent that no consideration is transferred to effect the combination or the consideration transferred is not representative of the acquirer s interest in the fair value of the business acquired. For combinations involving mutual entities the IASB also agreed to include in the exposure draft guidance on measuring the fair value of an acquired mutual entity similar to that being considered by the FASB and the Canadian AcSB.These IASB decisions eliminate a significant difference with US GAAP. The FASB s exposure draft arising from this project will likewise apply to business combinations involving mutual entities and to business combinations by contract. 12 IASB INSIGHT, October November 2004

13 PROJECT UPDATE Extractive activities The IASB approved IFRS 6 Exploration for and Evaluation of Mineral Resources in September, subject to ballot. Project manager Colin Fleming introduces the new IFRS. Extractive activities (mining and oil and gas production) are an important sector but few jurisdictions have comprehensive standards for such activities. IFRS 6 provides an interim solution that enables entities reporting exploration and evaluation assets to comply with IFRSs while avoiding wholesale changes to their accounting practices. It is a precursor to a comprehensive review of accounting for all aspects of extractive activities. This approach is similar to that adopted by the IASB in IFRS 4 Insurance Contracts. The reason for developing IFRS 6 lies in the interaction between existing industry practice and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Paragraphs of IAS 8 specify a hierarchy of criteria that an entity should use in developing an accounting policy if no IFRS applies specifically to an item. The IASB received representations from entities engaged in extractive activities that an entity adopting IFRSs would need to assess whether its accounting policies for the exploration for and evaluation of mineral resources complied with IAS 8. Currently, the methods used by entities in the mining and oil and gas sectors are diverse. In the absence of guidance, there might have been uncertainty about what would be acceptable under IFRSs. Establishing what would be acceptable could have been costly and some entities might have made major changes in 2005 followed by further significant changes once the IASB completes its comprehensive review of accounting for extractive activities. To avoid unnecessary disruption for both users and preparers at this stage, the IASB proposed to limit the need for entities to change their existing accounting policies for exploration and evaluation assets. The IASB has done this by: (a) creating a temporary exemption from parts of the hierarchy in IAS 8 that specify the criteria an entity uses in developing an accounting policy if no IFRS applies specifically. (b) limiting the impact of that exemption from the hierarchy by identifying expenditures to be included in and excluded from exploration and evaluation assets and requiring all exploration and evaluation assets to be assessed for impairment. The IASB published its proposals in January 2004 as ED 6 Exploration for and Evaluation of Mineral Resources. The comment letters received showed that there were two principal areas of controversy: the proposed exemption from parts of IAS 8 and the proposed impairment test for any exploration and evaluation assets recognised. Exemption from parts of IAS 8 IFRS 6 permits an entity to develop an accounting policy for exploration and evaluation assets without specifically considering the requirements of paragraphs 11 and 12 of IAS 8. Thus an entity adopting the IFRS may continue to use the accounting policies applied on the basis of accounting that it used immediately before adopting the IFRS. The accounting practices of entities engaged in the exploration for and evaluation of mineral resources range from deferring nearly all exploration and evaluation expenditure on the balance sheet to recognising all such expenditure in profit or loss as incurred. Under the IFRS, these various practices will be permitted to continue. Given this variability, some respondents to ED 6 opposed the exemption from the hierarchy. They were concerned that entities could give the appearance of compliance with IFRSs while being inconsistent with the stated objectives of the IASB, ie to provide users of financial statements with financial information that was of high quality, transparent and comparable. They also found it difficult to draw a meaningful distinction between the exploration for and evaluation of mineral resources and scientific research. Both activities can be costly and have significant risks of failure. The IASB shared these concerns, but concluded that it could not make an informed judgement in advance of the comprehensive review of accounting for extractive activities. Impairment When it developed ED 6, the IASB decided that an entity recognising exploration and evaluation assets should test them for impairment, using the test in IAS 36. Respondents accepted this general proposition but pointed out that exploration and evaluation assets do not always generate cash flows, particularly in exploration-only entities, and there is sometimes insufficient information about the mineral resources in a specific area for an entity to make reasonable estimates of exploration and evaluation assets recoverable amount. If so this would lead to an immediate write-off of exploration assets in many cases. The IASB was persuaded by respondents arguments that recognising impairment losses on this basis was potentially inconsistent with permitting existing methods of accounting for exploration and evaluation assets to continue. Therefore, pending completion of the comprehensive review of accounting for extractive activities, the IASB decided that the assessment of impairment should be triggered by changes in facts and circumstances. However, once an entity has determined that an exploration and evaluation asset is impaired, IAS 36 should be used to measure, present and disclose that impairment in the financial statements, subject to special requirements with respect to the level at which impairment is assessed. When developing ED 6, the IASB decided that there was a need for consistency between the level at which costs were accumulated and the level at which impairment was assessed. Consequently, ED 6 proposed that an entity recognising exploration and evaluation assets should make a one-time election to test those assets either at the level of the IASB INSIGHT, October November

14 PROJECT UPDATE IAS 36 cash-generating unit (CGU) or at the level of a special CGU. Respondents disagreed with the proposal. They did not accept that the special CGU would provide the relief it was intended to give. In addition, there was concern that, because the exploration and evaluation assets could be aggregated with other assets in the special CGU, there would be confusion about the appropriate measurement model to apply (fair value less costs to sell or value in use). The IASB acknowledged that the special CGU seemed to be more confusing than helpful and was prepared to delete it. However, it also noted that paragraph 22 of IAS 36 requires impairment to be assessed at the individual asset level unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. In addition, paragraph 70 of IAS 36 requires that if an active market exists for the output produced by an asset or group of assets, that asset or group of assets shall be identified as a cash-generating unit. In some cases in which exploration and evaluation assets are recognised, eg in the petroleum sector, each well is potentially capable of producing future cash inflows that are observable and capable of reliable measurement because there is an active market for crude oil. The IASB was concerned that removing the special CGU would cause entities recognising exploration and evaluation assets to test for impairment at a very low level. It therefore undertook a further consultation. The matter was highlighted in the July 2004 edition of IASB Update, and in the project summary and the Effect of Redeliberations documents available on the IASB s Website. These documents were also sent to the IASB s research project team and others with a request to encourage their constituents to respond. The IASB received 16 comment letters. The majority of respondents continued to support the elimination of the special CGU. They also supported the notion that entities should test impairment at the level of the cost centre and suggested that the IASB should consider defining an asset as it applied to exploration and evaluation assets. The respondents argued that such an approach would reflect more accurately the way in which the industry manages its operations. The IASB accepted these arguments and decided to permit entities some flexibility in allocating exploration and evaluation assets to cash-generating units or groups of units, subject to an upper limit: such units or groups of units can be no larger than a segment based on either the entity s primary or secondary reporting format determined in accordance with IAS 14 Segment Reporting. Effective date and transition ED 6 proposed that the IFRS should be effective for annual periods beginning on or after 1 January The IASB decided to change the effective date to 1 January 2006 to allow entities more time to make the transition to the IFRS. It also decided to permit an entity that wishes or is required to adopt IFRSs before 1 January 2006 to adopt IFRS 6 early. The IASB did not propose any special transition in ED 6. Some respondents expressed concern about the application of the proposals to prior periods especially those related to impairment and the inclusion or exclusion of certain expenditures from exploration and evaluation assets. For consistency with IFRS 4, the IASB concluded that, if it is impracticable to apply the impairment test to comparative information that relates to annual periods beginning before 1 January 2006, an entity should disclose that fact. Some respondents were concerned that entities would have difficulty in compiling the information necessary for 2004 comparative figures, and suggested that entities should be exempted from restating comparatives on transition, given that the IFRS would be introduced close to 1 January 2005, and could result in substantial changes. The IASB considered a similar issue when it developed ED 7 Financial Instruments: Disclosures, in which it concluded that entities that apply the requirements proposed only when they become mandatory should be required to provide comparative disclosures because such entities will have enough time to prepare the information. For consistency, the IASB agreed to amend IFRS 1 First-time Adoption of International Financial Reporting Standards to permit an entity that both (a) adopts IFRSs for the first time before 1 January 2006 and (b) applies IFRS 6 before that date exemption from producing comparative information in the first year of application. Research project The IASB has asked a group of staff from the national standard-setters in Australia, Canada, Norway and South Africa to undertake a research project, building on the results of the Issues Paper published in 2000 by IASC and the responses to it, and develop proposals for standard-setting projects. This project team has access to an advisory panel, which will provide advice on various aspects of the project team s work. The panel consists of individuals from entities with extractive activities (both oil and gas and mining); analysts and other users of financial statements; auditors; and securities regulators. The project team has undertaken a detailed examination of the comments received from constituents on the IASC Issues Paper and is developing its research priorities. In particular, the project team intends to consider all issues associated with accounting for upstream extractive activities. The project team will report its findings to the IASB during 2005 as necessary. 14 IASB INSIGHT, October November 2004

15 PROJECT UPDATE Post-employment benefits Project manager Anne McGeachin reports. In April 2004 the IASB published an exposure draft of amendments to IAS 19 Employee Benefits. The proposals covered three areas: the recognition of actuarial gains and losses, group plans and disclosures. The IASB has recently been redeliberating the proposals in the light of the comments received. It has agreed to proceed with the proposal to add an option to IAS 19 that would allow entities to recognise actuarial gains and losses in full in the period in which they occur outside profit or loss in a statement of recognised income and expense. The IASB also agreed that the requirements for group plans in the individual or separate financial statements of group entities should be amended to require a group entity to obtain information about the plan as a whole measured in accordance with IAS 19 on the basis of assumptions applicable to the plan as a whole. If there is a contractual agreement or stated policy for charging the net defined benefit cost measured in this way, the group entity must recognise an allocation of the net defined benefit cost determined in accordance with the contractual agreement or stated policy. If there is no such agreement or policy, the group entity must recognise a cost equal to the contribution charged for the period. In both cases, disclosures about the plan as a whole must be given. The IASB has also decided to incorporate into these amendments the clarification arising from its discussion of the IFRIC report on D6 Multi-employer Plans (see page 17). Lastly, the IASB has agreed to add disclosure requirements to IAS 19 to bring the disclosures closer to those required by the US standard SFAS 132 Employers Disclosures about Pensions and Other Postretirement Benefits. The IASB expects to issue amendments in December Revenue recognition The IASB is working on a joint project with the US FASB on revenue recognition. IASB project manager Jim Paul reports. (For developments up to January 2004, see the January 2003 and January 2004 editions of Insight.) The IASB is progressing a project on revenue recognition jointly with the FASB. The IASB s objective is to develop a comprehensive set of principles for revenue recognition that will lead to a revision of the IASB Framework and IAS 18 Revenue. A discussion paper setting out the boards preliminary views on revenue recognition principles is expected late in Board discussions The IASB has discussed the following topics so far this year: the meaning of contracts the definition of revenues how to measure the fair value of performance obligations to customers the reliability threshold for estimates affecting revenue recognition. Contracts The meaning of contracts was discussed because it affects how to apply the IASB s draft conceptual model for recognising unconditional contractual rights and obligations as assets and liabilities (see the January 2004 edition of Insight for a summary of that model). The IASB tentatively decided that: a contract should be defined as a set of promises that a court will enforce. an unconditional contractual right need not be worthy of enforcement (ie the benefits of enforcement need not exceed the costs) to meet the definition of an asset. the assessment of the probability that (i) unconditional contractual rights will result in future inflows of economic benefits and (ii) unconditional contractual obligations will result in future sacrifices of economic benefits should affect the measurement of the related assets and liabilities, but not whether they are recognised. cancellation provisions granted to customers do not make contracts unenforceable, but do affect the nature and measurement of the unconditional rights and obligations that arise from the contracts. The definition of revenues The IASB continued its discussion of the definition of revenues, and tentatively decided that: the present distinction between revenues and gains should be sharpened, and this might require other components of comprehensive income to be defined. production can give rise to a component of comprehensive income. performance by third parties of the entity s obligations to deliver goods or render services to customers gives rise to revenues unless those third parties legally assume those obligations. At future meetings, the IASB will continue considering how to define revenues and whether production income meets the definition of revenues. How to measure the fair value of performance obligations to customers The IASB continued discussing how to measure the fair value of performance obligations. To advance the joint project it is using a working principle, consistent with the FASB s view, that performance obligations should be IASB INSIGHT, October November

16 PROJECT UPDATE measured at fair value. The IASB has yet to make a tentative decision on the appropriate measurement attribute(s) for assets and liabilities. The IASB agreed to make a tentative working assumption that, in concept, the fair value of a performance obligation is the price that would need to be paid to a third party of equivalent credit standing to assume, at the measurement date, legal responsibility for performing all of the entity s remaining obligations. Such a transaction would occur in a business-to-business market. The IASB will consider further how to measure the fair value of performance obligations when it discusses reliability issues and explores applying the draft conceptual model for unconditional contractual rights and obligations to a broader array of customer contracts. Consistently with that tentative working assumption, the IASB tentatively decided that if an entity incurs performance obligations by contracting directly with customers, and simultaneously incurs identical performance obligations by legally assuming them from other businesses, the fair values of those obligations should not differ. The fair values of those identical obligations incurred in different markets (retail and business-to-business) should not differ even if the consideration received by the entity in each market differs. Reliability threshold for estimates affecting revenue recognition The IASB discussed the reliability threshold for estimates affecting revenue recognition and tentatively decided that this threshold should be the same as for estimates affecting other components of profit or loss. It also discussed with the FASB how guidance proposed in the FASB s exposure draft Fair Value Measurements could be applied when measuring the fair value of performance obligations to customers. That discussion focused on the evidence of fair value aspects of that exposure draft. In that regard, the IASB tentatively decided that: in the absence of evidence to the contrary, actual exchange prices (in other than active markets) should be presumed to represent fair value. prices in proposed exchange transactions may be used as market inputs to estimate fair value. fair value estimates of performance obligations incorporating significant entity inputs may be consistent with the fair value measurement objective. The IASB also discussed examples of direct and indirect measures of the fair value of performance obligations, to assess whether those measures would be sufficiently reliable to merit recognition in financial statements. The discussion was exploratory in nature, and no decisions were made. Forthcoming topics In the coming months, the IASB expects to consider papers on the definition of revenues; the measurement of performance guarantees; and accounting for wholly executory contracts. Interpretations Colin Fleming reviews the recent activities of the International Financial Reporting Interpretations Committee. The IFRIC has continued to make progress on its agenda, approving several Interpretations and completing work on draft Interpretations on service concession arrangements and liabilities arising from participating in a specific market. Interpretations D1 Emission Rights The IFRIC released Draft Interpretation D1 Emission Rights in May 2003, and redeliberated its conclusions in September and December At that time the IFRIC confirmed its view that D1 represented the most appropriate interpretation of current IFRSs. However, for a variety of reasons, final approval of the Interpretation was postponed until September 2004, when the IFRIC approved an Interpretation based on D1, subject to the following changes: In D1, the IFRIC proposed that allowances should not be amortised but should be tested for impairment in accordance with IAS 36 Impairment of Assets. Although the IFRIC maintained its view that, conceptually, allowances should not be amortised, it concluded that this treatment would not always be consistent with the requirements of IAS 38 Intangible Assets. Therefore, the IFRIC decided that it could not specify that allowances should not be amortised in all circumstances. However, if the allowances were traded in an active market (as defined in IAS 38) no amortisation would be required. In D1, the IFRIC proposed that the cash penalty that would be incurred if a participant failed to deliver sufficient allowances to cover its actual emissions should be taken into account in measuring the provision for the obligation to deliver allowances. The IFRIC noted that it would be unusual for a cap and trade scheme to allow a participant to satisfy its environmental obligation with a cash payment and therefore concluded that the penalty should be treated separately from the obligation to deliver allowances. It noted that the penalty would be within the scope of IAS 37 but decided that there was no need to provide specific guidance on this point. D3 Determining whether an Arrangement contains a Lease In June 2004 the IFRIC decided to adopt the wording in US GAAP (ie EITF 01-8 Determining Whether an Arrangement Contains a Lease) for determining whether an arrangement contains a lease. Many respondents to D3 had suggested this, as had preparer constituents who had met the 16 IASB INSIGHT, October November 2004

17 PROJECT UPDATE staff during July and August. Some participants in those meetings had highlighted difficulties in assessing whether their arrangements satisfied the criteria in the EITF approach, but the IFRIC decided that none of these difficulties pointed to fundamental flaws or gave rise to insurmountable application problems. In October the IFRIC approved an Interpretation based on D3. D4 Decommissioning, Restoration and Environmental Rehabilitation Funds In September the IFRIC approved an Interpretation based on D4. The Interpretation states that rights to reimbursement in services are economically similar to rights to reimbursement in cash both of these rights should be accounted for in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets and an amendment to IAS 39 Financial Instruments: Recognition and Measurement should be made to achieve this in the absence of guidance on measurement in IAS 37, the IFRIC should give guidance that both types of reimbursement rights are measured at fair value through profit and loss. The Interpretation will clarify that a residual interest in a fund, such as a contractual right to distributions once all the decommissioning has been completed or on winding-up of the fund, may be a financial instrument within the scope of IAS 39. D7 Scope of SIC-12 In October the IFRIC approved an amendment to SIC-12 Consolidation Special Purpose Entities: to remove the scope exclusion for equity compensation plans. to add a scope exclusion for other long-term employee benefit plans. In other words, the IFRIC agreed that paragraph 6 of SIC-12 should be amended as follows (new text is underlined and deleted text is struck through). This Interpretation does not apply to post-employment benefit plans or equity compensation plans other long-term employee benefit plans. Other redeliberations D6 Multi-employer Plans Respondents to D6 expressed concern about the general lack of availability of information about multi-employer plans and questions about the relevance of the information that would be generated by allocating elements of plans on the basis of current data, such as current contributions, percentage of payroll or head count. Consequently, the IFRIC agreed not to proceed with D6 as currently drafted. The IASB received a report from the IFRIC on this matter in October. The IASB decided to clarify in IAS 19 Employee Benefits that: if the entity accounts for its participation in the plan on a defined contribution basis in accordance with paragraph 30 because sufficient information was not available to use defined benefit accounting but there is a contractual agreement on the distribution of a surplus or funding of a deficit the contractual agreement gives rise to an asset or liability that should be recognised. The clarification will be included in the forthcoming amendments to IAS 19 (see page 15). D8 Members Shares in Co-operative Entities In November the IFRIC approved an Interpretation based on D8. In finalising D8, the IFRIC clarified the application of the prohibition on redemption. Restrictions such as conditions relating to available cash, reserves, liquidity, distributable profits etc that can prevent redemption only if certain conditions are met (or not met) are conditional restrictions that do not result in equity classification. On the other hand, restrictions that unconditionally prevent redemption result in equity classification. The IFRIC removed the distinction in D8 between a reclassification and an extinguishment. The IFRIC decided not to address in this Interpretation when a gain or loss should be recognised on a transfer between liabilities and equity, given that the focus of the Interpretation is classification rather than measurement. The IFRIC will include in the Basis for Conclusions a reminder that entities whose members shares are not equity may use the presentation formats included in paragraphs IE32 and IE33 of the illustrative examples with IAS 32. The Interpretation will also clarify that an entity assesses the classification of members shares and similar instruments as liabilities or equity on the basis of local laws, regulations and its governing charter in effect at the date of classification. Accordingly, an entity does not take into account expected future amendments to local laws, regulations or its governing charter. The IASB will consider the Interpretation at its meeting in November. The IFRIC intends to issue the Interpretation by the end of The IFRIC Agenda Committee is expected to consider whether the following matters should be the subject of future Interpretations: subsequent measurement of the financial liability for the redemption of members shares when a gain or loss should be recognised on a transfer between liabilities and equity. Draft Interpretations Service concession arrangements The IFRIC expects to approve the following Draft Interpretations in November: Service Concession Arrangements Determining the Accounting Model IASB INSIGHT, October November

18 BUSINESS COMBINATIONS phase I Service Concession Arrangements The Receivable Model Service Concession Arrangements The Intangible Asset Model The first of those drafts addresses, for arrangements within its scope: whether the infrastructure transferred under the terms of the service concession should be recognised as property, plant and equipment of the operator; and which accounting model applies to the arrangements, and in what circumstances. The draft specifies that the financial asset model applies to such arrangements when the operator provides cash or non-cash consideration in exchange for the right to the service concession, and: (a) the grantor has the primary responsibility to pay the operator, or (b) although the operator is entitled to be paid by users, the effect of the contractual arrangements is that the grantor retains substantially all of the demand risk associated with the service concession. Under the financial asset model, the right received by the operator in exchange for its cash or non-cash consideration is accounted for as a financial asset. The intangible asset model applies to such arrangements whenever the operator is entitled to be paid by users in such a way that the grantor has not got substantially all of the demand risk. Under the intangible asset model, the right received by the operator in exchange for its cash or non-cash consideration is accounted for as an intangible asset. Liabilities arising from Participating in a Specific Market Waste Electrical and Electronic Equipment EU Directives 2002/96/EC and 2003/108/EC on Waste Electrical and Electronic Equipment state that the cost of waste management for certain equipment will fall to producers of that type of equipment who are in the market when disposal occurs and not necessarily to the actual producers of that equipment. Thus future market share (ie market share at the time disposal occurs) will be the basis for determining the obligation. The IFRIC has approved a Draft Interpretation, which concludes that it is the participation in the market during the measurement period that constitutes the obligating event in accordance with paragraph 14(a) of IAS 37 Provisions, Contingent Liabilities and Contingent Assets. A liability does not arise when the products have been put onto the market, as no obligation is present until the measurement period has begun. The Draft Interpretations are expected to be published before the end of Business Combinations phase I Senior project manager Annette Kimmitt reports. IFRS 3 Business Combinations requires all business combinations to be accounted for by applying the purchase method. However, IFRS 3 excludes from its scope certain business combinations, including those involving two or more mutual entities and those in which separate entities are brought together to form a reporting entity by contract alone without the obtaining of an ownership interest. In finalising IFRS 3, the IASB was concerned that these two scope exclusions were not satisfactory. It therefore believed that an interim solution for the accounting for such combinations (ie a solution pending completion of phase II of the Business Combinations project) needed to be included in the stable platform of IFRSs applicable from 1 January The IASB published in April 2004 an exposure draft of Proposed Amendments to IFRS 3 Business Combinations: Combinations by Contract Alone or Involving Mutual Entities. The exposure draft proposed: to remove from IFRS 3 the scope exclusions for combinations involving mutual entities and by contract alone without the obtaining of an ownership interest. to require the entity identified as the acquirer to apply a modified version of the purchase method to account for such combinations. The modified version would require the acquirer to measure the cost of the combination as the net fair value of the acquiree s identifiable assets, liabilities and contingent liabilities, plus, in the case of combinations involving mutual entities, the fair value, at the date of exchange, of any assets given, liabilities incurred or assumed, or equity instruments issued by the acquirer in exchange for control of the acquiree. to make no amendments to the transitional and effective date requirements in IFRS 3. Therefore, entities would be required to apply the revised version of IFRS 3 arising from the exposure draft to account for all business combinations involving mutual entities or by contract alone without the obtaining of an ownership interest for which the agreement date is 31 March 2004 or later. The IASB considered analyses of the comment letters at its meeting in September Overview of respondents comments The majority of respondents disagreed with the proposals. Their reasons included the following: the IASB has recently decided to accelerate some of its phase II deliberations by addressing the accounting for combinations involving mutual entities or by contract alone without the obtaining of an ownership interest as part of its joint IASB/FASB project on purchase method procedures. An exposure draft is expected in 18 IASB INSIGHT, October November 2004

19 BUSINESS COMBINATIONS phase I the next quarter. There seems little reason for proceeding with an interim solution if it will shortly be replaced by a longer-term solution. the modified purchase method proposed in the exposure draft is inconsistent with IFRS 3. For example, the proposals would result in three different treatments for goodwill under IFRSs depending on whether the combination was by contract alone without the obtaining of an ownership interest, between two or more mutual entities or otherwise within the scope of IFRS 3. This contradicts the exposure draft s objective of reducing the number of methods of accounting for business combinations. Some respondents believe that existing purchase method procedures could be applied in most cases. Others believe that a fresh start method would be more appropriate than what they believe is a flawed modification to the purchase method. Others argued that the pooling of interests method should be retained. the proposed modified purchase method would result in a combination involving mutual entities being overstated whenever any consideration given by the acquirer in exchange for control of the acquiree exceeds the amount of goodwill in the acquiree. the amendments are being proposed too close to the 2005 deadline for adoption of IFRSs in Europe and other jurisdictions. Such late changes are inconsistent with the IASB s stated objective that the body of IFRSs to be applied for 2005 would be finalised by March 2004 and that any changes to IFRSs after that date would not be effective until IASB s response In the light of respondents comments, the IASB decided not to proceed with the proposals in the exposure draft, and instead to retain in IFRS 3 the scope exclusions for combinations involving mutual entities and by contract alone without the obtaining of an ownership interest, pending completion of the joint project on purchase method procedures. The IASB noted the following implications of this decision: entities would need to account for these business combinations by applying the requirements in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors on developing accounting policies in the absence of a standard or an interpretation that specifically applies to a transaction or event. in accordance with these requirements in IAS 8, management must use its judgement in developing and applying an accounting policy that results in information that is: relevant to the economic decision-making needs of users; and reliable, including that the financial statements reflect the economic substance of the transaction or event. In making this judgement, management must refer to, and consider the applicability of, the requirements and guidance in standards and interpretations dealing with similar and related issues, and the definitions, recognition criteria and measurement concepts in the Framework. Management may also consider the most recent pronouncements of other standard-setting bodies that use a similar conceptual framework, other accounting literature and accepted industry practice, but only to the extent that these do not conflict either with the guidance in standards and interpretations dealing with similar and related issues or with the Framework. therefore, in applying the requirements of IAS 8, an entity may not apply a superseded standard, such as the version of IAS 22 Business Combinations that was withdrawn in March However, entities would be permitted to look to IFRS 3 for guidance. Other issues raised by respondents Combinations by contract alone without the obtaining of an ownership interest Some respondents were uncertain about the types of transactions encompassed by the term by contract alone without the obtaining of an ownership interest. For example, would the following features imply that a combination was not by contract alone without the obtaining of an ownership interest? Stapling transactions *. By legal form these are not by contract alone without the obtaining of an ownership interest, because the shareholders of each of the combining entities receive, at a nominal amount, equity instruments (ie ownership interests) in the other combining entity that are then stapled to their existing shareholdings. However, in economic substance such transactions can be regarded as no different from a dual listing. Cash or other payments. The contractual arrangements underpinning a dual listing or a security stapling often involve transactions in anticipation of the combination, such as one of the combining entities paying special dividends or issuing bonus shares to its existing shareholders immediately before the combination is effected. The purpose of such transactions is to equalise the value of the combining entities equity instruments immediately before the combination is * Stapled securities refers to a situation in which a listed legal entity (typically a company) has issued equity instruments that are combined with ( stapled to) the equity instruments issued by another legal entity (typically a trust). The stapled securities cannot be traded independently and are quoted at a single price. The stapling results in the two (or more) legal entities having equity holders in common. Such transactions are generally tax-driven. They meet the IFRS 3 definition of a business combination because they in substance involve the bringing together of separate entities or business into one reporting entity (a reporting entity is defined in IFRS 3 as one for which there are users who rely on the entity s general purpose financial statements for information that will be useful to them for making decisions about the allocation of resources. A reporting entity can be a single entity or a group ). IASB INSIGHT, October November

20 BUSINESS COMBINATIONS phase I effected. Are such payments pre-combination or should they be regarded as consideration paid in the business combination? Direct investment in the other combining entity. It is not clear whether a combination could be regarded as by contract alone without the obtaining of an ownership interest when one of the combining entities has a pre-existing ownership interest in the other combining entity, or the combination is predominantly by contract while at the same time involving some consideration being given by the acquirer for an ownership interest in the acquiree. For example, the formation of a dual listed corporation may, as part of the contractual arrangement, involve the acquirer obtaining a small parcel of shares in the acquiree, but this ownership interest on its own (ie without the other terms of the contract) does not give the acquirer control of the acquiree. In considering this issue, the IASB observed that the term by contract alone without the obtaining of an ownership interest was intended to capture (and thus exclude from IFRS 3) any business combination in which the obtaining of control by one of the combining entities was effected solely as a result of contractual arrangements, without the combination itself involving any of the combining entities (as opposed to their shareholders) obtaining an ownership interest in the other combining entity (or entities). This is because: although identification of the acquirer rests on the notion of control, the purchase method in IFRS 3 is a cost allocation model, with cost being the fair value given by the acquirer in exchange for control of the acquiree (plus any costs incurred by the acquirer that are directly attributable to the combination). complications arise in applying IFRS 3 s version of the purchase method when there is no cost in the traditional sense given by the acquirer in exchange for that control. * a distinction needs to be drawn between reverse acquisitions (for which the IASB has developed guidance on applying the purchase method), and other combinations intended to be excluded from IFRS 3 for which there is no cost given by the acquirer in exchange for control. The distinction is that a reverse acquisition involves one of the combining entities, even though not the acquirer for accounting purposes, obtaining an ownership interest in the other combining entity. Applying this reasoning results in the following conclusions: the stapling transactions referred to by respondents are intended to be captured by the term by contract alone without the obtaining of an ownership interest. This is * This includes reverse acquisitions because there is no cost in the traditional sense given by the acquirer in exchange for control it is the legal acquirer (ie the acquiree for accounting purposes) that purchases an ownership interest in the legal acquiree (ie the acquirer for accounting purposes). because such combinations are effected by contract without one of the combining entities obtaining an ownership interest in the other combining entity. the cash or other payments referred to by respondents that are made in anticipation of a dual listing or security stapling are pre-combination transactions they are not a cost given by the acquirer in exchange for control of the acquiree nor do they result in one of the combining entities obtaining an ownership interest in the other combining entity. if a combination is predominantly by contract while at the same time involving some consideration being given by the acquirer for an ownership interest in the acquiree, it is not a combination by contract alone without the obtaining of an ownership interest. This would include, for example, the formation of a dual listed corporation that also involves the acquirer obtaining an ownership interest in the acquiree when that ownership interest on its own (ie without the other terms of the contract) does not give the acquirer control of the acquiree. Consequently, such combinations would have to be accounted for by applying the purchase method principles in IFRS 3. This means that goodwill would be recognised by the acquirer, but only to the extent that it is attributable to the ownership interest held by the acquirer in the acquiree. Identifying an acquirer and the interaction between IFRS 3 and IAS 27 A business combination is defined in IFRS 3 as the bringing together of separate entities or businesses into one reporting entity. The IASB s view is that as with any traditional business combination, when separate mutual entities are brought together into one reporting entity or when separate entities are brought together solely as a result of contractual arrangements without the obtaining of an ownership interest, the result generally is that one of the combining entities ends up controlling the other(s). Nevertheless, the Basis for Conclusions on IFRS 3 leaves open the possibility (however rare) that a business combination might not involve one of the combining entities obtaining control of the other(s). The IASB was concerned that some constituents have suggested that if a business combination did not result in one of the combining entities obtaining control of the other(s), the entity identified as the acquirer for the purposes of applying IFRS 3 would not meet the definition in IAS 27 Consolidated and Separate Financial Statements of a parent (ie an entity that has one or more subsidiaries ). Therefore, the acquirer would not be required to prepare consolidated financial statements. The IASB noted that: IFRS 3 defines the acquirer in a business combination as the combining entity that obtains control of the other combining entities or businesses. A subsidiary is defined as an entity that is controlled by another entity. 20 IASB INSIGHT, October November 2004

21 REPORT control has the same definition in IFRS 3 as in IAS 27 (ie the power to govern the financial and operating policies of an entity or business so as to obtain benefits from its activities). the intended interaction between IFRS 3 and IAS 27 is that an entity that is identified as the acquirer of another entity in accordance with IFRS 3, is a parent for the purposes of IAS 27. In other words, the requirement in IAS 27 for a parent to prepare consolidated financial statements applies to all entities that are, in accordance with IFRS 3, identified as the acquirer of another entity. Communication with respondents Given its decision not to proceed with the proposals in the exposure draft, the IASB directed the staff provide each of the respondents to the exposure draft with a summary of the IASB s redeliberations (as reported in the September 2004 edition of Update). IASB meets partner standard-setters At a meeting held in London on 27 and 29 September 2004, the IASB met representatives of national standard-setters from Australia, Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States. Also present was the Observer delegation from the European Financial Reporting Advisory Group (EFRAG). European endorsement of IAS 39 Discussion focused on the European Commission s proposal to carve out sections of IAS 39 Financial Instruments: Recognition and Measurement before the standard was endorsed for adoption throughout the European Union. The sections in question concerned the full fair value option and portfolio hedging of core deposits. The EFRAG observers acknowledged that those changes might have significant side-effects, but argued that they were a better alternative than not to endorse the standard at all. A critical technical concern was whether entities could make an explicit and unreserved statement of compliance with IFRSs if they adopted the EU-endorsed version of IAS 39. This statement is required for an entity to access the transitional concessions provided in IFRS 1 First-time Adoption of International Financial Reporting Standards. Otherwise, entities would have to follow the full retrospective approach in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. The EFRAG observers suggested that the EU would permit an explicit and unreserved statement of compliance even if an entity adopts the EU-endorsed version of IAS 39. The IASB also drew attention to proposals made by the European Banking Federation (FBE) for a new kind of hedge accounting for interest margin hedges. A group from the IASB had responded to the proposals with various points, and were awaiting the FBE s response. Review of operations The IASB reported that it was undertaking a review of its operations, with the aim of improving transparency and efficiency. Innovations being considered (some of which have already been implemented) included more detailed observer notes, increased availability of Web-based and other project materials, field visits and the publication of near-final drafts of forthcoming standards and interpretations (but not of exposure drafts). Advisory working groups had already been established for the Financial Instruments and Insurance projects, and a working group on Reporting Comprehensive Income would be appointed soon. Role of partner standard-setters The partner standard-setters identified various ways in which they could contribute to the development of IFRSs. These included assisting in the promotion of, and initial move to, IFRSs; identifying educational, implementation and interpretation issues; and providing technical support on research projects, interpretation and standard-setting projects. They could also help the IASB to communicate with constituents, and in the training of future standard-setting talent. In the interests of enhancing the role of partner standard-setters in technical discussions, participants considered several alternatives to the current meeting arrangements. The role of national standard-setters was also discussed at the annual meeting of national standard-setters held on 27 and 28 September 2004 (see page 22). Communication of financial information The IASB Framework focuses on issues of definition, recognition and measurement, rather than presentation and disclosure (together termed display ). However, standard-setters and preparers need consistent guidance on deciding what information should be provided in financial statements and how it should be presented. The meeting agreed that the main determinants of a draft Framework for Display were the information needs of users, the trade-off between relevance and reliability, the scope of financial statements, constraints on the provision of information (eg cost, confidentiality and information overload) and understandability. Measurement objectives The meeting noted that a discussion paper on measurement objectives was being prepared by a project team led by the Canadian Accounting Standards Board. Although the IASB intended to publish it in the near future, it would not contain the IASB s preliminary views. IASB INSIGHT, October November

22 REPORT Management s discussion and analysis (MD&A) A project team led by the New Zealand Financial Reporting Standards Board was developing a draft discussion paper on management commentary, such as MD&A. The paper would take a principle-based approach rather than proposing a checklist of minimum content requirements. Intangible assets A project team led by the Australian Accounting Standards Board was preparing material for an implementation review of aspects of IFRS 3 Business Combinations and IAS 38 Intangible Assets. This review was intended to assist in the definition, recognition and measurement of intangible assets. Joint ventures Responses to an international survey of accounting practices were being considered by a project team led by the Australian Accounting Standards Board. Feedback from the survey would be used as the basis for an issues paper on the topic. Investment companies EFRAG had been asked to look into the consolidation of investment companies. However, the EFRAG observer reported that more pressing matters and a shortage of resources had hampered progress. The matter would be raised again at a future meeting. IASB meets national standard-setters The IASB met representatives of national standard-setters from 47 countries in London on 27 and 28 September Role of national standard-setters (NSSs) Angus Thomson, Technical Director of the Australian Accounting Standards Board, opened the session by presenting a paper on the role of NSSs, and their relationship with the IASB. In the subsequent discussion, participants asked the IASB to increase the transparency of its processes to ensure that NSSs remain fully informed. They also urged the IASB to allow adequate lead time for them to implement IFRSs at national level. It was suggested that it might be helpful to keep a register of implementation issues raised by NSSs. Participants suggested that NSSs should encourage their constituents to participate directly in the IASB s process. NSSs should also identify and manage domestic regulatory barriers to the implementation of IFRSs, work closely with the IFRIC in the identification of issues and the development of interpretations and, in adopting IFRSs, avoid amending IFRSs in a manner that prevents full compliance with IFRSs. Participants agreed to develop a memorandum of understanding setting out responsibilities that the IASB and NSSs should use their best endeavours to meet in the interests of easing the adoption of and convergence with IFRSs. This topic was also discussed at the meeting with partner standard-setters on 27 and 29 September 2004 (see page 21). Challenges to the adoption of IFRSs IASB member Warren McGregor led a round-table discussion on the adoption of IFRSs worldwide. Representatives from Argentina (Jorge Gil), India (Subhash Chander Vasudeva), Malaysia (Zainal Abidin Putih), New Zealand (Joanna Perry) and Poland (Jacek Gdanski) made presentations opening the round-table discussion. The response to a questionnaire distributed before the meeting was discussed. The survey revealed that, although all jurisdictions that responded were moving to embrace IFRSs for publicly listed entities in their consolidated financial statements, they were taking different approaches and were at different stages in the process. The survey also revealed that in many jurisdictions the IASB s bases for conclusions and implementation guidance were not available, possibly because of translation problems. The discussion showed that the challenges facing jurisdictions included (i) political or process impediments such as cultural resistance or domestic laws, (ii) technical impediments such as sector neutrality or implementation difficulties and (iii) the need for education initiatives particularly regarding the accounting for financial instruments, inflation and employee benefits. Presentation by Donald T Nicolaisen, Chief Accountant, US Securities and Exchange Commission Mr Nicolaisen expressed his belief that, given the continuing progress towards convergence of IFRSs and US GAAP, the SEC would be able to eliminate the reconciliation requirement to US GAAP for listed companies from outside the US that use IFRSs and register with the SEC. The SEC expected as many as 500 such filings in 2005, and planned to review these statements in the second half of 2006 to assess the experience and knowledge of those adopting IFRSs. However, Mr Nicolaisen stressed that the removal of the reconciliation requirement would be predicated on a strong, independent IASB that continues to develop and issue high quality standards. It would also require a commitment to quality application of IFRSs, continued progress in accounting convergence and the development of an effective global financial reporting infrastructure. A transcript of the speech is available on the SEC Website ( Conceptual frameworks IASB member James Leisenring gave a presentation on the IASB and US FASB frameworks. Both frameworks view decision-usefulness of information to a broad group of outsiders as being the purpose of financial reporting. Both frameworks are said to take a balance sheet view. However, a more accurate characterisation would be to say that both frameworks give conceptual primacy to assets and liabilities. An alternative income statement view would require revenue and expenses to have conceptual primacy. 22 IASB INSIGHT, October November 2004

23 TRUSTEES NEWS That would necessitate definitions of revenues and expense without regard to changes in assets or liabilities, or the view would lack intellectual rigour. Consolidations (including special purpose entities) Annette Kimmitt, a senior project manager at the IASB, gave an overview of the IASB s deliberations. The project aims to develop a comprehensive definition of control that would apply to all entities (including special purpose entities), to develop guidance on applying that definition, and to consider consolidation procedures. The NSS participants, in a series of small group discussions, gave their comments on three case studies concerning consolidation in the absence of legal control, the dual role of fund managers and timing anomalies in the recognition of assets. Leases: a contractual rights and obligations approach Andrew Lennard, Technical Director of the UK Accounting Standards Board, reported on the IASB s deliberations. The project was taking a conceptual approach to accounting for leases, which would provide a basis for recognising assets and liabilities that are representative of the contractual rights and obligations of lessees and lessors. The meeting considered several issues, including whether the conceptual model of contractual rights and obligations was preferable to other approaches, such as the whole asset approach, refining the existing finance/operating lease model or improving footnote disclosures. The IASCF Education initiative Elizabeth Hickey, the IASCF Director of Education, outlined the IASCF s Education Plan, which aims to encourage the consistent and rigorous implementation of IFRSs. NSSs can assist in achieving this end by making the IASCF aware of their educational needs. Educational materials will include: summaries of each standard in both non-technical and technical language educational learn about modules practical how to examples and implementation guides. Plans are in hand for an electronic disclosure checklist that can be tailored to the entity s circumstances. Vacancy for IFRIC member The IASC Foundation has published the following notice Vacancy for IFRIC member The Trustees of the International Accounting Standards Committee (IASC) Foundation invite applications from suitable candidates to fill one position on the International Financial Reporting Interpretations Committee (IFRIC). The IFRIC is the interpretative body of the International Accounting Standards Board (IASB) and consists of twelve voting members under the non-voting chairmanship of the IASB s Director of Technical Activities. The role of the IFRIC is to interpret the application of International Financial Reporting Standards (IFRSs) to ensure consistent accounting practices throughout the world and to provide timely guidance on financial reporting issues not specifically addressed in IFRSs, within the context of the IASB s Framework. The IASB and the IFRIC are overseen by the nineteen Trustees of the IASC Foundation, chaired by Paul A Volcker, who also appoint the members of those bodies. Members of the IFRIC are chosen on the basis of their accounting expertise, relevant experience, and ability to identify and address issues concerning the practical application of IFRSs. Those wishing to be considered for membership must therefore possess a high degree of relevant technical expertise and practical experience. Other important qualifications include a substantial knowledge of the global business environment and a high level of ability in analytical and judicious decision-making. The Trustees of the IASC Foundation will appoint one member to the IFRIC to serve the remainder of a term that will expire on 30 June Members are eligible for reappointment. Members are expected to attend about nine two-day meetings each year held in London. Membership is unpaid, but the IASC Foundation meets members expenses of travel on IFRIC business. Please indicate interest by sending a covering letter and curriculum vitae by 15 December 2004 to Mr Philip Laskawy, Chairman of the Nominating Committee of the Trustees, IASC Foundation, 30 Cannon Street, London EC4M 6XH, United Kingdom. IASB INSIGHT, October November

24 TRUSTEES NEWS IASC Foundation reappoints three Trustees On 27 October the Trustees of the International Accounting Standards Committee (IASC) Foundation announced the reappointment of three of the Trustees, with effect from 1 January Malcolm Knight, General Manager, Bank for International Settlements; Jens Røder, Partner, PricewaterhouseCoopers, Denmark; and Roberto Teixeira da Costa, first Chairman, Brazilian Securities and Exchange Commission (CVM), will each serve a further term of three years until 31 December The Trustees have also announced that John Biggs, Guido Ferrarini, and Koji Tajika will retire as Trustees when their terms expire on 31 December The Trustees have initiated the search for candidates to fill the vacancies (see notice on page 24). To meet the requirements of the IASC Foundation Constitution (currently under review), one of the Trustees to be appointed should have senior experience in accounting, and will be appointed after consultation with and nomination by the International Federation of Accountants. Another of those appointed must have a background in the user community, which could include senior experience in investment organisations, regulatory bodies or analyst institutions. Commenting on the reappointments, Paul A Volcker, Chairman of the Trustees, said, The Trustees are delighted that the organisation will continue to benefit from the expertise and broad experience of Malcolm Knight, Jens Røder and Roberto Teixeira da Costa. All six of the Trustees whose terms expire at the end of this year have been tireless advocates for the cause of high quality international accounting standards, and we greatly appreciate the work that John Biggs, Guido Ferrarini and Koji Tajika have done on behalf of the organisation. Vacancies as Trustees The IASC Foundation has published the following notice International Accounting Standards Committee Foundation Trustees from Asia-Pacific/Europe/North America The International Accounting Standards Committee (IASC) Foundation is the private sector independent body responsible for the development and promulgation of a single set of high quality international accounting standards. Nineteen Trustees of the IASC Foundation, chaired by Paul A Volcker, oversee the Foundation and the International Accounting Standards Board (IASB). The IASB is the 14-member body responsible for the development of international accounting standards. The Trustees of the IASC Foundation wish to appoint three Trustees one each from the Asia-Pacific region, Europe and North America. One of those appointed should have senior experience in accounting, and will be appointed after consultation with and nomination by the International Federation of Accountants (IFAC). Another of those appointed must have a background in the user community, which could include senior experience in investment organisations, regulatory bodies or analyst institutions. The appointments will be for the three years expiring on 31 December Terms may be renewed for a further three years. Qualified candidates should be committed to the IASB s mission as a high quality global standard-setter, be financially knowledgeable, and be able to meet the time commitment. Trustees are expected to have an understanding of, and be sensitive to, international issues relevant to the success of an international organisation responsible for the development of global accounting standards for use in the world s capital markets. Trustees responsibilities include ensuring financing for the organisation; appointments to the IASB, the Standards Advisory Council and the International Financial Reporting Interpretations Committee; and general oversight of the organisation. Please indicate interest by sending a covering letter and CV by 30 November 2004 to Paul A Volcker, Chairman of the Trustees, IASC Foundation, 30 Cannon Street, London EC4M 6XH, United Kingdom or by to Tom Seidenstein, Director of Operations, at tseidenstein@iasb.org 24 IASB INSIGHT, October November 2004

25 STAFF Director of Technical Activities Kevin Stevenson, IASB Director of Technical Activities, to return to Australia The IASB has announced that Kevin Stevenson will be resigning as Director of Technical Activities in the first half of 2005 in order to return to his native Australia. Mr Stevenson became the IASB s first Director of Technical Activities in February In that role, he helped to ensure the successful completion of the IASB s initial work programme, which has provided a platform of high quality accounting standards ready for use in countries adopting International Financial Reporting Standards (IFRSs) in Mr Stevenson has also served as the first non-voting Chairman of the International Financial Reporting Interpretations Committee (IFRIC). Commenting on Mr Stevenson s decision to return to Australia, Sir David Tweedie, IASB Chairman, said, The IASB is extremely sorry that Kevin is leaving, but we recognise that he wants to return to Australia to spend more time with his family. Kevin has been instrumental both in ensuring that the IASB completed its initial work programme to provide the stable platform of standards for 2005 and in achieving real progress on the convergence of international and national accounting standards. He has also helped to ensure that the IFRIC has played its full role in the development of international practice. He has been a tireless worker for the IASB and we know that he will continue to make a strong contribution on behalf of the IASB upon his return to Australia. I want to thank Kevin for his massive contribution to the launch of the IASB on the international scene. The IASB has initiated a search for Mr Stevenson s successor and has posted the following advertisement International Accounting Standards Board Director of Technical Activities The International Accounting Standards Board (IASB) invites applications for appointment as its Director of Technical Activities. This position is located in London. The Director of Technical Activities reports to the Chairman of the IASB and, in conjunction with the Director of Research, is responsible for the Board s technical programme and for management of the technical staff and processes. In addition, the Director serves as the non-voting chair of the International Financial Reporting Interpretations Committee. The Director s responsibilities involve all aspects of the IASB s work, including attendance at Board meetings and relations with the Board members, and liaison with the Standards Advisory Council and the IASB s worldwide constituents, national standard-setters, regulators and others. The Director of Technical Activities works with the Director of Research and is supported by the technical project staff. The Director is responsible for ensuring that the technical staffing is appropriate to the organisation s needs, and must be able to develop and motivate staff. Applicants should have substantial experience in accounting standard-setting. They need expertise in financial reporting concepts and are likely to have extensive practical experience of financial reporting. The IASB s working language is English and the Director s role requires excellent written and oral communication skills and presentational abilities. Although based in London, the job entails frequent overseas travel. The remuneration for this challenging high profile appointment is commensurate with experience. Interested candidates should send their CV to Tom Seidenstein, Director of Operations, by tseidenstein@iasb.org.uk, no later than 6 January International Accounting Standards Board IASB INSIGHT, October November

26 STAFF Staff changes Comings Three new members of the technical staff have arrived. In August Joan Brown joined as a project manager. She has previously been a project director at the UK Accounting Standards Board and has also worked in the technical accounting departments of Deloitte in London and the UK tax authority. Initially she will manage the IFRIC project on service concessions. Also in August, Noreen Whelan, a certified accountant from Ireland, joined as an industry fellow on secondment from General Electric (GE), where she most recently served as Assistant Regional Controller Europe. Previously at GE she held roles in financial planning, treasury, and Six Sigma process improvement, and spent time in Asia, Europe and the US. Before joining GE she worked for a Swedish bank. In September Kil-woo Lee, a member of the Korean Institute of Certified Public Accountants, joined as a visiting fellow on secondment from the Korea Accounting Standards Board. At the KASB he led various projects, including those on property, plant and equipment, troubled-debt restructurings, equity transactions, and interpretation issues. Before joining the KASB, he worked for accounting firms in Korea providing auditing, tax and consulting services. Two new members of the Publications staff have been appointed. In September Isabella Nordio joined as a translation assistant. A native of Italy, she studied English language and literature at university in Milan. She worked in Italy in conservation before coming to London where she graduated with a Masters in Technical Translation at the University of Westminster. She has been living in the UK for four years. In October Larissa Nixon joined as a database manager. and goings Three members of the technical staff have left. In October Kathie Bugg completed her secondment as a practice fellow and returned to Deloittes in the US, where she will specialise in assisting clients with IFRS issues. At the IASB she had worked primarily on convergence projects, notably on income taxes, earnings per share and property, plant and equipment. In October Kevin Singleton, a senior practice fellow, left to take up an appointment with a leading bank. He had worked on the Improvements project and IFRIC 1 and developed the three draft Interpretations being considered on service concessions. Sue Lloyd, project manager, decided to return to the world of merchant banking. At the IASB she had planned and developed the project on consolidations, managed the research project on lease accounting, and assisted both the Improvements project and the work of the Business Combinations team. and other changes In October, Ailie Burlinson stepped down after 17 years as Sir David Tweedie s secretary and personal assistant to fill a new post as secretary to the Director of Education. Janet Smy, who has been working at Cannon Street on a temporary basis, has been appointed to succeed her as the Chairman s personal assistant. 26 IASB INSIGHT, October November 2004

27 BV2004 Ad V1 7/11/04 6:51 pm Page INTERNATIONAL FINANCIAL REPORTING STANDARDS (BOUND VOLUME) This complete text features all International Financial Reporting Standards (IFRS), International Accounting Standards (IAS), Interpretations and IASB-issued supporting documentation - Bases for Conclusions, Implementation Guidance and Illustrative Examples. International Financial Reporting Standards (IFRSs ) On CD-ROM including IASB Exposure Drafts, IFRIC Draft Interpretations, Discussion Papers and other IASB and IASC Foundation materials International Accounting Standards Board IFRSs as at 1 August 2004 Also available... International Financial Reporting Standards (IFRSs), A Briefing for Chief Executives, Audit Committees and Boards of Directors This handy guide provides an overview of each Standard in non-technical language. Copies cost each The 2004 Bound Volume includes new International Financial Reporting Standards for: IFRS 1, First-time Adoption of International Financial Reporting Standards; IFRS 2, Share-based Payment; IFRS 3, Business Combinations; IFRS 4, Insurance Contracts; IFRS 5, Non-current Assets Held for Sale and Discontinued Operations. This volume also includes the latest revisions of and amendments to all International Accounting Standards as at 31 March 2004, including: Improvements to International Accounting Standards 2003; IAS 32 Financial Instruments: Disclosure and Presentation; IAS 36 Impairment of Assets and IAS 38 Intangible Assets; and IAS 39 Financial Instruments: Recognition and Measurement (including the amendment on Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk). The volume also includes the IASB Framework for the Preparation and Presentation of Financial Statements, the Preface to International Financial Reporting Standards, an updated Glossary of Terms, and a new comprehensive Index. Copies cost each International Accounting Standards Committee Foundation International Financial Reporting Standards are now available on a new, easy to use CD-ROM. Get updates throughout the year - an annual subscription includes all new, revised and amended IFRSs, new IFRIC Interpretations, IASB exposure drafts and discussion papers, IFRIC draft interpretations and more - visit for more details. Single user version each TO FIND OUT MORE VISIT THE BOOKSHOP AT