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Blog Article

Whatever Happened to Convergence?

Wednesday 30 April 2014

IASB Work Plan Overview

Written by Bill Kemp, Senior IFRS Instructor, IASeminars

Below you will find information about major IASB projects, which we will update as they progress. Further information can be found directly on the IASB website.

Since 2002 the agendas of the International Accounting Standards Board (IASB) and its US counterpart, the Financial Accounting Standards Board (FASB), have been directed at developing improved, converged accounting standards. The focus over the last five years has been on four major topics: financial instruments, leases, revenue and insurance contracts. The Boards originally planned to publish new standards in 2011 but none has yet been completed.

The FASB has chosen to abandon the goal of convergence with financial instruments and insurance contracts and to go its own way: in each case it now aims for what it calls 'targeted improvements to existing GAAP'. The Boards intend to publish a 'substantially converged' revenue standard by the middle of 2014. A joint meeting in March 2014 indicated differences of approach on a number of issues relating to leasing, but work continues to try and achieve a converged solution.

It is for others to allocate blame for the failure to develop converged solutions but the effects will be felt for years to come. The goal of a single set of high quality global standards is as far away as ever - unless everybody else adopts US GAAP! For the foreseeable future, convergence is off the agenda.

The focus hereafter is on the IASB's Work Plan at March 26, 2014.That plan is still dominated by the major convergence projects: financial instruments, leases, revenue and insurance contracts. Follow these quick links to our article explaining where these projects currently stand:

IFRS 9Financial Instruments: Replacement of IAS 39

The project to replace IAS 39Financial Instruments: Recognition and Measurementhas been carried out in phases. Three major elements had to be addressed: classification and measurement, impairment and hedging. Preparers have been allowed to mix and match IAS 39 and IFRS 9 by early adopting chapters of the new standard as they are published. The Board's current thinking is that IFRS 9 will be mandatory for annual periods beginning on or after January 1, 2018. At one time IFRS 9 was to be compulsory from 2013. This was postponed until 2015 but, due to its failure to complete the standard, the Board has had to delay implementation for the second time.

Classification and measurement

In 2009 and 2010 the Board issued chapters of the new standard, IFRS 9, on classification, measurement and derecognition of financial assets and financial liabilities. The aim was to simplify classification and measurement requirements and to make them more 'principles-based'. To this end IFRS 9 requires that most financial assets are measured at fair value and gains and losses are recognised in profit or loss, fair value through profit or loss. Exceptionally, amortised cost is the appropriate measurement basis for assets held within a business model whose purpose is to collect the contractual cash flows consisting solely of payments of interest and principal. The FASB was unable to agree to this approach and has abandoned the goal of convergence.

In November 2012, the IASB published an Exposure Draft of limited amendments to its classification and measurement requirements in IFRS 9. The intention was to align IFRS 9 more closely with the approach then being developed by the FASB. This involved introducing an additional compulsory classification of financial assets at 'fair value through other comprehensive income' (FVTOCI). This would apply to debt instruments held in a business model whose objective is both to hold assets to collect contractual cash flows and to sell them.

The Board aims to publish final amendments to IFRS 9's classification and measurement chapters in the second quarter of 2014.

Impairment

IAS 39 applies the 'incurred loss' model to determine impairment of financial assets. Under that model, an impairment loss is only recognised after a loss event (e.g. a delinquency in payments of principal or interest) has already occurred. During the financial crisis of 2008, this approach was criticised for resulting in recognising credit losses too little and too late.

Following years of discussion and various proposals, the IASB published a revised Exposure Draft in March 2013, recommending an 'expected loss' model. This recognises expected credit losses resulting from deterioration in the creditworthiness of the counterparty. Recognition of a credit loss/impairment would no longer depend on the entity first identifying a loss event that occurred prior to the reporting date.

Although both Boards are committed to the expected loss model, they did not agree on precise measurement of the losses and are going their separate ways. The IASB aims to publish the chapter on impairment of financial assets in the second quarter of 2014.

Hedging

The IASB divided its consideration of hedging into two sections: 'general' and 'macro' hedging. Macro hedging is less common, being mainly found in the financial sector. It refers to 'dynamic risk management' where net risk positions on portfolios of assets that change over time are mitigated by adjusting hedging instruments. Traditional/general hedge accounting is difficult to apply to these situations as it requires one-to-one designation of hedged items and hedging instruments. In March 2014 the Board published a Discussion Paper on macro hedging: this sought reactions by October 2014 to a possible way forward, called the 'Portfolio Revaluation Approach to Macro Hedging'.

In November 2013, the IASB published IFRS 9's chapter on general hedging. The new hedge accounting model differs significantly from IAS 39 (and from current US GAAP). IAS 39 was criticised for failing to reflect entities' risk management policies and for being too complex and difficult to apply and interpret. IFRS 9 extends eligible hedging instruments and hedged items, relaxes the qualifying criteria for applying hedge accounting by applying a more principles-based approach to determining hedge effectiveness, only requires effectiveness to be tested prospectively and amends disclosures to make them more relevant. Consequently hedge accounting is expected to be available more widely, particularly for entities outside the financial sector.

The FASB has not yet considered amendments to hedge accounting in US GAAP. It will do so when it has completed its work on classification and measurement and impairment. Regrettably the prospect of a single global standard on accounting for financial instruments is dead and buried. It is interesting to know the reaction of the G20 nations who demanded in October 2008 that the Boards develop urgently an improved and converged standard. Ten years later (and counting), there is no prospect of success.

Note that IASeminars will cover these new developments in the following courses which are currently scheduled in such locations as London, Toronto, Calgary, Las Vegas and Dubai - plus others.

Leases

In August 2010 the Boards published joint Exposure Drafts proposing new accounting models for lessees and lessors. In May 2013 they re-exposed amended proposals. Redeliberations are likely to continue throughout 2014 and no date is currently targeted for publication of a standard.

Accounting by lessees

The common ground has been that lessees should recognise an asset representing the right to use the underlying asset during the lease term and a liability to make the lease payments. This would bring all leases onto the balance sheet. An exception is proposed which would allow short-term leases to remain off balance sheet. A short-term lease is defined as one with a maximum possible term, including any options to renew or extend, of 12 months or less. This corresponds to IAS 17's treatment of operating leases.

What remains unresolved is the basis of recognition in profit or loss of lease expenses. May 2013's Exposure Drafts proposed a dual-reporting model. This required lessees to classify each lease as Type A or Type B. Most equipment and vehicle leases would be Type A, reflecting the fact that a significant part of the underlying asset's service capacity is consumed during the lease term: the expenses recognised would consist of straight-line amortisation of the right-of-use asset and a finance cost on the lease liability at the effective interest rate. This is consistent with IAS 17's accounting for finance leases and produces higher expenses in the early years of a lease. Most property leases would be Type B, reflecting the fact that the service capacity of the asset (land and buildings) is not significantly depleted during the lease term: lease expense would be recognised on a straight-line basis, made up of interest on the lease liability (reducing over the lease term) and amortisation of the right-of-use asset (increasing over the same period). This would produce a similar result to IAS 17's accounting for operating leases.

During joint redeliberations in March 2014, the Boards could not agree on a way forward. The IASB favoured a single-reporting model, effectively accounting for all leases as Type A. The FASB voted for a version of the dual-reporting model, whereby most existing capital/finance leases would be accounted for as Type A and most existing operating leases would be accounted for as Type B. The IASB claims that its approach is sounder conceptually and the FASB aims to produce the least disruptive solution for preparers. The Boards will try to reach a converged position.

Accounting by lessors

The IASB's thinking has almost come full circle back to IAS 17. The first Exposure Draft in 2010 proposed that lessors should apply one of two models depending on the extent of exposure to risks or benefits relating to the underlying asset. The May 2013 Exposure Draft proposed different lessor accounting requirements. As for lessees, lessors were to be able to elect to account for short-term leases in the same way as IAS 17 currently treats operating leases: recognise rental income on a straight-line basis over the term of the lease and amortise the underlying asset systematically over its useful life. Other leases would be classified as either Type A or Type B. Generally equipment and vehicles would be type A and property would be Type B.

Type B leases would be accounted for similarly to current operating leases, as in the proposals for short-term leases. Lessors of Type A leases would apply the so-called 'receivable and residual approach'. The lessor would allocate the carrying amount of the leased asset between a lease receivable (measured initially at the present value of the lease payments) and a residual asset. Finance income would subsequently be recognised on that receivable using the effective interest method. The initial measurement of the residual asset would consist of the following amounts:

  • the gross residual asset (which is the present value of the estimated residual value at the end of the lease term) less
  • any deferred profit (which is the difference between the gross residual asset and the amount of the underlying asset's carrying amount allocated to the residual asset).

Finance income would then be recognised by accreting the gross residual asset at the rate implicit in the lease.

In March 2014 The IASB decided to drop the receivable and residual proposal and effectively revert to lessor accounting similar to IAS 17's distinction between finance and operating leases.

Note that IASeminars will cover these new developments in the following courses which are currently scheduled in such locations as London, Toronto, Calgary, Las Vegas and Dubai - plus others.

Revenue

In November 2011, the IASB and the FASB published a revised Exposure Draft to improve and converge the requirements of IFRSs and US GAAP for revenue from contracts with customers. The objective is to create a single, principles-based revenue recognition standard that would apply to all industries and all types of revenue-generating transactions and which will replace IAS 11Construction Contractsand IAS 18 Revenue.

The core principle of the revised Exposure Draft is that a company should recognize revenue in an amount which reflects the consideration to which it expects to be entitled in exchange for the transfer of goods or services to a customer. Lease contracts, insurance contracts and financial instruments are excluded from the scope of the draft. According to the Exposure Draft, revenue recognition is based on a five step approach:

  • Step 1: Identify the contracts with customers(i.e. identify the bundle of contractual rights and obligations to which the entity has to apply the revenue recognition rules). For example, it may be necessary to combine some contracts and to treat them as one contract for accounting purposes.
  • Step 2: Identify the separate performance obligation(s)(i.e. identify the promised goods or services that should be accounted for separately). Performance obligations represent promises in a contract to transfer goods or services to a customer.
  • Step 3: Determine the transaction price(i.e. determine the amount of consideration to which the entity expects to be entitled in exchange for the promised goods or services).
  • Step 4: Allocate the transaction price:If there is more than one performance obligation, the transaction price (i.e. the revenue to be recognized) has to be allocated to these obligations.
  • Step 5: Recognize revenuewhen (or as) the entity satisfies a performance obligation by transferring a promised good or service to the customer. This means that, according to the draft standard, it is necessary to determine whether revenue has to be recognised over time or at a point of time. When the consideration is variable, the cumulative amount of revenue recognised is limited to the amount to which the entity is reasonably assured to be entitled.

The IASB intends that the new standard will be published in late May 2014. In February 2013 a tentative decision was made to apply the new standard for annual periods beginning on or after January 1, 2017. Early adoption will not be permitted.The FASB is expected to issue a 'substantially' converged standard at the same time.

Note that IASeminars will cover these new developments in the following courses which are currently scheduled in such locations as London, Toronto, Calgary, Las Vegas and Dubai - plus others.

Insurance Contracts

Accounting for insurance contracts is currently dealt with in IFRS 4. This is an interim standard which permits insurers to continue with their existing accounting policies for insurance contracts that they issue (and reinsurance contracts that they hold), if those policies meet certain minimum criteria. The intention has always been to replace IFRS 4.

The objective of the IASB's project on insurance contracts is to provide a principles-based approach for all types of insurance contracts. In July 2010, the Board issued an Exposure Draft. The proposals were intended to eliminate inconsistencies and weaknesses in existing practices. The FASB had joined the project in 2008 and a joint Exposure Draft was published in June 2013. In March 2014 the FASB effectively withdrew, having decided to limit the scope of its project and to focus on targeted improvements to existing US GAAP.

The Exposure Draft proposed a comprehensive measurement approach for all types of insurance contracts issued (and reinsurance contracts held). An insurer would have to apply a measurement approach which uses the following building blocks:

  • Expected present value of future cash outflows
  • Expected present value of future cash inflows
  • Risk adjustment - FASB was not in favour of this adjustment
  • Contractual service margin

No date is targeted for publishing the standard. The IASB has proposed a GAAP of approximately three years between publication and mandatory adoption: this makes it extremely unlikely that it will be mandatory before 2018.

Note that IASeminars will cover these new developments in the following courses which are currently scheduled in such locations as London, Toronto, Calgary, Las Vegas and Dubai - plus others.

About the Author

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