Operating segments

The IASB agreed to consider the case for a project that would seek to achieve convergence between US GAAP and IFRS on the topic of Segmental Reporting. It has been deemed to be a short-term convergence project and the convergence date is 2006, with the IFRS being effective from January 2007. The IASB is planning to publish an exposure draft of its proposals in January.

Currently US GAAP and the International Standards adopt different approaches to segmental reporting. The US standard FAS 131 Disclosure about Segments of an Enterprise and Related Information adopts a 'managerial approach', whereas IAS 14 Segment Reporting focuses more on disaggregation of consolidated financial statements. These two approaches are fundamentally different and the IASB is likely to propose that it should adopt FAS 131 and make it into an IFRS. The scope of the standard will apply to (a) listed companies and (b) mutuals and unlisted banks.

The main issue of concern with the proposed new IFRS is not the managerial approach, which seems both reasonable and logical in terms of defining segments; but that it allows the information reported for segments not to have to be reconcilable to GAAP.

Under the managerial approach financial information is required to be reported on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. This may result in differences between the measurements used in operating segment information and those used in the entity's main financial statements. The two bases may be different.

It is possible to allocate an expense to a segment without allocating the related asset. The related assets may be allocated to a different segment, but the standard is explicit in the requirement for a company to disclose in this case. Asymmetry regarding assets and their related expenses is a proposition which could alarm purists; but does lend weight to the idea that, for segment reporting, relevance is the dominant factor.

Conceptual framework

The IASB and the US Financial Accounting Standards Board (FASB) are pressing ahead with their joint project to revisit their conceptual frameworks for financial accounting and reporting. The goal of the project is to develop a common conceptual framework that both Boards can use in developing new and revised accounting standards. The Boards have not given the world a Christmas present in the form of a due process document for public comment, but their discussions to date are provoking a lot of debate.

The Boards' discussions to date have focused on the objectives and qualitative characteristics of financial reporting. On objectives, the Boards propose that the converged framework should identify as the primary users of financial reports "present and potential investors and creditors, and their advisers". While most would accept that financial statements are useful to a wide range of users, this goes wider than the ASB's defining class of user (present and potential investors), which in itself is wider than a focus on the current shareholders that many in the UK would like to see. This could impact on the future debate as to whether a proprietary view or an entity view is used to determine the boundary of a reporting entity.

It also impacts on the overriding objective of financial reporting, which the Boards propose should be to provide information to assist users in making economic decisions. But what are economic decisions? Are they simply decisions on whether to sell shares or buy more, or do they include shareholder rights, as owners, to change the direction of the business, or the management? Some ASB constituents believe that the Boards are placing too much emphasis on buy/sell decisions alone, given their proposal that stewardship should not be included as a specific objective of financial reporting, but that the converged framework should simply acknowledge that financial information may be useful for assessing management's stewardship responsibilities and accountability.

The discussions on qualitative characteristics have also not been without controversy. Relevance, understandability and comparability survive, but the Boards are proposing that reliability should be dropped from the converged framework, as it is a "widely misinterpreted" term. Instead, as the IASB 'Observer Notes' reveal, the Boards are proposing to replace it with "faithful representation", which is described in the box below:

We hope that's clear to you! If so, please include a simple explanation of what it means in your Christmas card to the ASB.

The Boards have also been developing a process for assessing the qualitative characteristics that would tax even the most dedicated devotees of puzzles. We have not reproduced the process chart here, but those curious enough should take a look at the version in the IASB's 'Observer Notes' for October at http://www.iasb.org/uploaded_files/doc uments/8_1168_0510ob08.pdf.

Given all the above, it does seem somewhat odd that the Boards are proposing that the first due process document, on objectives and qualitative characteristics, should be an exposure draft, rather than a discussion paper, on the grounds that the proposals involve mostly "refinements" or "clarifications" of the existing frameworks.

And there's more…as well as starting to discuss the reporting entity concept, the Boards are also turning their minds to considering the elements of financial reporting. Early indications are that these discussions could also throw up some interesting and controversial issues. The ASB will continue to monitor closely the project and report developments.

As reported in the last edition of Inside Track, the staff at the ASB has submitted some comments on the project to the IASB/FASB team, a copy of which can be accessed on the ASB website at http://www.frc.org.uk/images/uploaded /documents/FrameworksMemoLetter% 20and%20Memo.pdf

Other presents we expect to see under the tree include ...

Reporting Financial Performance

The IASB is continuing with its project on the format of the income statement, building on the earlier joint project with the ASB. At present debate is focused on whether or not a separate 'financing' category should be disclosed in the income statement, and how such a category should be defined. The ASB's academic panel recently debated a paper on this issue, analysing the more conceptual approaches to a possible definition. Meanwhile, the IASB is finalising an exposure draft of the first stage of this project. The main proposal is expected to be for a single performance statement, reporting all recognised gains and losses (other than transactions with owners), with the existing net profit figure being a subtotal in the middle of the statement; but allowing a choice of presenting this as two separate statements (similar to the UK profit and loss account and statement of total recognised gains and losses).

Leases

ASB project director Simon Peerless will be working with IASB on the project into lease accounting, considering how to develop the proposals set out in the G4+1 discussion paper of 1999. Under these proposals the distinction between operating and finance leases would be removed. All leases will be accounted for as the acquisition by the lessee of the right to use the asset for the period of the lease; and this right should be recognised as an asset on the lessee's balance sheet, with a corresponding obligation for lease payments.

Borrowing costs

The IASB is considering converging IAS 23 'Borrowing Costs', which permits entities to choose whether or not to capitalise borrowing costs relating to the period of construction of a tangible fixed asset, with the US statement SFAS 34, which require capitalisation in all cases. The IASB are considering removing the option in IAS 23; however, other significant differences, such as what interest costs are to be included, and the start and end points of the capitalisation period, would remain. As these are both old standards, neither is viewed as representing a 'high quality' solution in line with modern thinking, and a major project would be required to develop a new standard. The UK standard FRS 15, like IAS 23, permits a choice of capitalisation and non-capitalisation.

Technical Corrections

The IASB has decided not to proceed with approving a policy for technical corrections to standards, but to use instead the existing process of amendments, with a short (30-day) exposure period and electronic-only publication of exposure drafts. The first draft technical correction has been confirmed as an amendment to IAS 21 without further exposure. The ASB is issuing an equivalent amendment to FRS 23.

Consolidations (including Special Purpose Entities)

The IASB has a project on consolidations. The project objectives are:

• to develop a comprehensive definition of control;
• to consider the circumstance in which SPEs should be consolidated based on the concept of control developed; and
• to address both consolidation policy and procedure.

The IASB have tentatively agreed that control of an entity is the ability to direct the strategic financing and operating policies of an entity so as to access benefits flowing from the entity and increase, maintain or protect the amount of those benefits.

Recently the IASB has considered:

• options held of assets versus options over equity instruments;
• the attribution of profits and losses in the context of potential voting rights;
• the nature of an investment in an entity when setting the operating and financing policies of the entity has been put on 'autopilot';
• disclosure required when judgement is required in deciding whether one entity controls another.

The IASB will continue to develop the control model before issuing an Exposure Draft.

In October the IASB issued a statement to highlight its views on de facto control. The statement includes the IASB's view that the control concept in IAS 27 includes de facto control. The statement acknowledges, however, that differences in how IAS 27 is applied might persist until its project on control is completed.

EU endorsement update

The European Commission has issued a statement to make clear that any International Financial Reporting Standard (IFRS) adopted and published in the Official Journal by the date the accounts are signed (rather than the end of the financial year) can be used in the preparation of the accounts for that financial year (as long as the standard does not prohibit early adoption).

A status report on the endorsement of IFRS in the EU is available on the EFRAG website at www.efrag.org.