Welcome to IASB Update

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The topics discussed at the joint IASB/FASB meeting were:

• Asset and liability offsetting
• IFRS 9: Financial instruments: classification and measurement: Education session on FASB model
• Impairment
• Insurance contracts
• Investment property: Education session on FASB project
• Leases
• Revenue recognition

The topics discussed at the IASB meeting were:

• Agenda consultation: proposed timetable
• Annual improvements: comment period
• Investment entities: sweep issues

The IASB and the FASB discussed alternative approaches for requiring offsetting financial assets and financial liabilities on the face of the balance sheet. The staff proposed the following alternatives:

1. Alternative 1-This approach requires a right of set-off that is exercisable both in the normal course of business and in bankruptcy, insolvency, or default and intention to settle a financial asset and financial liability net or simultaneously.
2. Alternative 2-This approach requires a right of set-off that is legally enforceable in the normal course of business and intention to settle a financial asset and financial liability net or simultaneously.
3. Alternative 3-For derivative instruments, this approach provides an exception from the general offsetting criteria, which would allow offsetting of fair value amounts recognized for derivatives and fair value amounts recognised for the right to reclaim cash collateral or the obligation to return cash collateral arising from derivative instrument(s) recognised at fair value with the same counterparty under a master netting agreement. This approach requires a right of set-off that is only enforceable in bankruptcy, insolvency, or default of one of the counterparties.
1. Alternative 3a-This approach limits the exception for offsetting derivative instruments under Alternative 3 to only collateralized derivatives with daily variation margin postings.

The IASB supported Alternative 1. The majority of the FASB supported Alternative 3.

The boards noted that users consistently asked that information be provided to help reconcile any differences in the offsetting requirements for IFRSs and US GAAP so the boards decided to work on converging disclosure requirements to assist users comparing financial statements prepared in accordance with IFRSs and US GAAP.

FASB staff presented to the boards a summary of tentative decisions reached by the FASB on classification and measurement of financial instruments. The meeting was informational; no decisions were reached.

The boards discussed a 'three-bucket' expected loss approach for the impairment of financial assets.

The guiding principle of the 'three-bucket' approach is to reflect the general pattern of deterioration of credit quality of loans. Allowance balances would be established for all financial assets subject to impairment accounting. The different phases of the deterioration in credit quality are captured through the 'three-buckets' that determine the allowance balance. Generally, the 'three-bucket' approach would encompass the following:

• Bucket 1: in the context of portfolios, assets evaluated collectively for impairment that do not meet the criteria of Buckets 2 or 3 (this would include loans that have suffered changes in credit loss expectations as a result of macroeconomic events that are not particular to either a group of loans or specific loan).
• Bucket 2: Assets affected by the occurrence of events which indicate a direct relationship to possible future defaults, however the specific assets in danger of default have not yet been identified.
• Bucket 3: Assets for which information is available that specifically identifies that credit losses are expected to, or have, occurred on individual assets.

The boards decided to continue to develop the 'three-bucket' approach. In addition, the boards agreed with the broad approach to distinguish between the buckets on the basis of credit risk deterioration. The boards decided that the allowance balance of Buckets 2 and 3 should be the remaining lifetime expected loss estimate.

The boards provided the following direction to the staff for future deliberations:

• Pursue an approach for Bucket 1 with an overall objective of recognising an impairment allowance equal to 12 months' worth of expected losses based on initial expectations plus the full amount of any changes in expected credit losses. However, the boards also noted the operational complexities of such a model, and directed the staff to consider how to operationalise the approach.
• The boards noted the importance of having clear and well-defined indicators and guidance related to when to transfer assets between Buckets 1, 2, and 3. Therefore, they instructed the staff to further develop criteria to determine which of the three buckets financial assets should be attributed to.

The IASB and FASB continued their discussions on insurance contracts. They considered the following topics: whether and how to unlock the residual margin, allocation methods for the residual margin and the accounting for acquisition costs.

Whether to unlock the residual margin

The IASB tentatively decided that the residual margin should not be locked in at inception. 8 IASB members supported and 7 members opposed this decision.

The FASB indicated unanimously that they would not favour unlocking the residual margin after inception if the FASB were to adopt an approach that includes both a risk adjustment and a residual margin, rather than the single-margin approach tentatively decided on by the FASB.

How to unlock the residual margin

The IASB tentatively decided that an insurer should:

1. adjust the residual margin for favourable and unfavourable changes in the estimates of future cash flows used to measure the insurance liability. Experience adjustments would be recognised in profit or loss. 11 IASB members supported this decision and 4 opposed it.
2. not limit increases in the residual margin. 12 IASB members supported and 3 opposed this decision.
3. recognise changes in the risk adjustment in profit or loss in the period of the change. 9 IASB members supported and 6 opposed this decision.
4. make any adjustments to the residual margin prospectively. 10 IASB members supported and 5 members opposed this decision.

The IASB discussed whether changes in discount rate should be recognised as an adjustment to the residual margin or in profit or loss in the period of the change to the extent that these changes create an accounting mismatch. No decision was made.

The FASB did not vote on how to unlock the residual margin.

Allocation methods for residual margin

The IASB tentatively decided that:

1. the residual margin should not be negative. All IASB members supported this decision.
2. insurers should allocate the residual margin over the coverage period on a systematic basis that is consistent with the pattern of transfer of services provided under the contract. 9 IASB members supported and 6 opposed this decision.

Acquisition costs

The boards tentatively decided that the acquisition costs to be included in the initial measurement of a portfolio of insurance contracts should be all the direct costs that the insurer will incur in acquiring the contracts in the portfolio, and should exclude indirect costs such as:

• software dedicated to contract acquisition
• equipment maintenance and depreciation
• agent and sales staff recruiting and training
• administration
• rent and occupancy
• utilities
• other general overhead
• advertising

14 IASB members supported and 1 opposed this decision. All FASB members supported this decision.

In addition:

1. the IASB tentatively decided that no distinction should be made between successful acquisition efforts and unsuccessful efforts. 9 IASB members supported and 6 opposed this decision.
2. the FASB tentatively decided that the acquisition costs included in the cash flows of insurance contracts will be limited to those costs related to successful acquisition efforts. All FASB members supported this decision.

Next steps

Both boards will continue their discussion on insurance contracts on Tuesday 14 June 2011 by considering presentation in the statement of comprehensive income.

FASB staff presented the IASB with an overview of decisions made in the FASB's investment properties project. The session was only for educational purposes, and the boards were not asked to reach any decisions.

The IASB and the FASB discussed Shariah-compliant lease contracts, lessor accounting, subleases and short-term leases.

Shariah-compliant lease contracts

The boards discussed the accounting implications of applying a right-of-use lease model to Shariah-compliant lease contracts. The discussion was educational in nature and no decisions were made.

Lessor accounting

The boards continued discussing the accounting by lessors under a right-of-use model.

The boards discussed a single approach to lessor accounting whereby the lessor would recognise a lease receivable and a residual asset at lease commencement. The boards will consider at a future meeting whether, and if so when, under such an approach, it is appropriate for a lessor to recognise profit at lease commencement. The boards will also consider at a future meeting whether there should be different lessor models for (a) a lease of a portion of an asset and (b) a lease of an entire asset.

The boards did not make any decisions about lessor accounting at this meeting.

Subleases

The boards discussed the accounting for subleases under the proposed leases requirements for lessees and lessors and tentatively decided the following:

1. A head lease and a sublease should be accounted for as separate transactions.
2. An intermediate lessor, as a lessee in a head lease arrangement, should account for its assets and liabilities arising from the head lease in accordance with the decisions to date for all lessees.
3. An intermediate lessor, as a lessor in a sublease arrangement, should account for its assets and liabilities arising from the sublease in accordance with the decisions to date for all lessors.
4. If the Boards decide that there should be more than one approach to lessor accounting, an intermediate lessor, as a lessor in a sublease, should evaluate its right-of-use asset, not the underlying asset, to determine the appropriate lessor accounting approach to apply to the sublease.

All board members present agreed.

Short-term leases

The boards discussed the accounting for short-term leases by lessees. A short-term lease is defined as follows: A lease that, at the date of commencement of the lease, has a maximum possible term, including any options to renew, of 12 months or less.

The boards tentatively decided that, for short-term leases, a lessee need not recognise lease assets or lease liabilities. For those leases, the lessee should recognise lease payments in profit or loss on a straight-line basis over the lease term, unless another systematic and rational basis is more representative of the time pattern in which use is derived from the underlying asset. Nine IASB members and six FASB members agreed.

The boards also tentatively decided that a lessee may elect to apply the recognition and measurement requirements in the leases guidance to short-term leases. Twelve IASB members and five FASB members agreed.

The boards expressed support for requiring disclosure of the rental expense recognised in the current period and a statement about the extent to which that expense is expected to be representative of rental expense in future periods. The boards will continue to discuss disclosures for short-term leases, as well as lessor accounting for short-term leases, at a future meeting.

The IASB and the FASB completed their planned redeliberations of the exposure draft Revenue from Contracts with Customers by discussing the following topics:

1. The effect of the proposed standard on telecommunications (and other) companies
2. The transition requirements for the proposed standard
3. Whether it is necessary to re-expose the proposed standard.

Effect of the proposed standard on telecommunications (and other) companies

The boards discussed concerns raised by constituents in the telecommunications industry about the effect of the boards' proposed standard. The boards tentatively decided to not revise the requirements of the proposed standard. This decision was supported by ten members of the IASB and five members of the FASB.

Transition requirements

The boards tentatively affirmed their decision in the exposure draft that an entity should apply the proposed standard on a retrospective basis. However, to ease the burden of applying the proposed standard in the first year of application, the boards tentatively decided that:

1. An entity should not be required to restate contracts that begin and end within the same reporting period.
2. An entity should be permitted to use hindsight in estimating variable consideration in the comparative reporting periods.
3. An entity should be required to perform the onerous test only at the effective date unless an onerous contract liability was recognised previously in a comparative period.
4. An entity should not be required to disclose the maturity analyses of remaining performance for prior periods.

An entity should apply any relief employed consistently to all transactions throughout the comparative periods.

The decision to propose retrospective application was supported by all members of the IASB and the FASB. The decision to provide entities with the transitional reliefs outlined above was supported by twelve members of the IASB and four members of the FASB.

The boards also tentatively decided that if an entity employs any of the available reliefs above, the entity should disclose the following information:

1. The reliefs that have been employed by the entity
2. To the extent possible, a qualitative assessment of the likely effect of applying those reliefs.

Those disclosures were supported by eight members of the IASB and five members of the FASB.

Re-exposure of the proposed standard

The boards agreed to re-expose their revised proposals for a common revenue recognition standard. Re-exposing the revised proposals will provide interested parties with an opportunity to comment on revisions the boards have undertaken since the publication of an exposure draft on revenue recognition in June 2010. Specifically, the boards plan to invite feedback on:

1. The extent to which the revised requirements are understandable and the drafting of the requirements has not created unintended consequences for specific contracts or industries
2. A few specific aspects of the revised requirements.

It was the unanimous view of the boards that while there was no formal due process requirement to re-expose the proposals it was appropriate to go beyond established due process given the importance of the revenue number to all companies and the need to take all possible steps to avoid unintended consequences. The boards intend to re-expose their work in the third quarter of 2011 for a comment period of 120 days.

Next steps

The boards directed the staff to draft an exposure draft for vote by written ballot. No board members indicated that they intend to dissent to the publication of the exposure draft.

The Board considered the proposed timing of the forthcoming agenda consultation. The Board tentatively agreed with the proposals, which anticipate launch of the consultation in July after discussion of the consultation plans with the IFRS Advisory Council and the IFRS Foundation Trustees. The Board tentatively agreed to a deadline of 30 November 2011 for comments on the agenda consultation.

The comment period for the forthcoming Improvements to IFRSs exposure draft was discussed at the Board meeting in May 2011 where the Board agreed with a 90-day comment period. Because the ED for the 2009-2011 cycle is expected to be published in June rather than in August, the Board tentatively decided that the comment period for this particular ED should be lengthened to 120 days.

The Board discussed two sweep issues in respect of publishing the exposure draft Investment Entities. Firstly, the Board unanimously agreed that early application of the amendment to IFRS 10 would be permitted, provided that the entity also applies IFRS 11 Joint Arrangements, IFRS 12 Disclosure of Interests in Other Entities, IAS 27 Separate Financial Statements and IAS 28 Investments in Associates and Joint Ventures (as amended in 2011) at the same time. The Board also agreed that the effective date of the amendment would be 1 January 2013. Secondly, the Board unanimously agreed that the exposure draft should have a comment period of not less than 120 days.