Conceptual Framework

As reported previously in Inside Track, the IASB and FASB are developing a common conceptual framework that they can both use in preparing new and revised accounting standards.

The first Discussion Paper (DP) was issued in July 2006, setting out the preliminary views of the two Boards on the objective of financial reporting and the qualitative characteristics of decision-useful financial reporting information. In recent months, the Boards have been considered the responses to that DP, with the aim of issuing an Exposure Draft (ED) in the third quarter of 2007.

The Boards are taking forward work on a number of other phases of the project; for example, a DP on the reporting entity is scheduled to be issued during the second quarter of 2007. In addition, work has begun on the measurement phase of the project, with a series of public roundtable meetings, one of which was held in London at the end of January, in which the ASB participated.

As reported previously, the ASB continues to work with the standardsetters in Australia, Canada and New Zealand (the ‘Group of Four’) to monitor the implications of the IASB/FASB project for public-benefit entities. In addition, the International Public Sector Accounting Standards Board (IPSASB) has started a project on a conceptual framework for the public sector, in which ASB staff are participating. The ASB is leading the work on developing proposals on the objectives of public sector financial reporting.

Leases

The IASB and FASB have commenced deliberation on their joint project for a revision of the leasing standards. The Boards considered an analysis of the assets and liabilities arising in a simple lease contract. They agreed that the 'right of use' model, where the lessee recognises an asset representing its right to use the leased item for the lease term and a corresponding liability for the lease rentals, whatever the term of the lease, was the only approach which recognised assets and liabilities that corresponded to the conceptual framework definitions. Staff were asked to develop this model further.

In February the ASB held a joint roundtable with the Finance Leasing Association (FLA) to discuss the IASB project and the proposed new approach. A summary of the discussion at the meeting is available on the ASB’s website at http://www.frc.org.uk/asb/about/pub1216.html.

Insurance

The IASB is shortly expected to issue its discussion paper on insurance contracts. This will set out proposals for a radical change in the way insurance business is accounted for, and would apply to all types of insurance, both general and life. It proposes a move to current values for all insurance liabilities, and would have a very significant effect for some types of insurance:

• general insurance liabilities would need to be based on best estimates of claims outcomes, taking account of current market-based risk margins and discount rates, rather than the present basis; and
• life assurance, although measured using a prospective calculation similar to that currently adopted by larger insurers, would also need to incorporate risk margins and other variables based on market rates.

The ASB will be considered the implications of the DP for insurance accounting in the UK, which is currently governed by the Companies Act, the Statement of Recommended Practice (SORP) on insurance business issued by the Association of British Insurers (ABI), and FRS 27 ‘Life Assurance’ or, for those insurance entities adopting international standards, IFRS 4 ‘Insurance Contracts’.

Earnings per share

The IASB is considering an amendment to IAS 33 ‘Earnings per share’ relating to the dilutive effect of options and warrants that are classified as liabilities. These would be excluded from diluted earnings per share as the fair value adjustments recognised on these instruments is a better reflection of the dilutive effect. One purpose of the amendment is to achieve convergence with the FASB on this issue, and the proposals replace previous decisions to amend the treasury stock method of calculating diluted earnings per share. An exposure draft is expected later this year. Given that FRS 22 ‘Earnings per share’ is fully converged with IAS 33, the ASB will consider making the same amendment.

Financial Statement Presentation

The IASB has redeliberated its proposals on the first phase of this project, set out in an exposure draft in 2006; the main proposals have been confirmed, including the requirement for all non-owner changes in equity in the period to be included in either a single statement of performance, or in a two statement form, an income statement and a separate statement of other income and expenditure. A final standard on this aspect of the project is expected in the second quarter of 2007.

Borrowing costs

The IASB has issued an amendment to IAS 23 ‘Borrowing Costs’, the main effect of which is to remove the option of expensing borrowing costs relating to the period of production of an asset. As previously stated in Inside Track 49, the ASB does not intend to amend the corresponding UK standard, FRS 15 ‘Tangible Fixed Assets’ as this is not a converged standard.

Amendment to FRS 20 (IFRS 2) ‘Share-based Payment’

The IASB will shortly be issuing in final form an amendment to IFRS 2 to clarify the treatment of a cancellation of share options by the holder – such as the decision in a Save-As-You-Earn (SAYE) scheme to cease contributions. The ASB proposed an equivalent amendment to FRS 20 as an exposure draft in March 2006, and will consider whether to make a corresponding amendment to FRS 20.

The Board has considered whether to amend FRS 20 to provide relief to subsidiaries that grant options over the equity shares of their parent and, under Urgent Issues Task Force (UITF) Abstract 44, account for these as cash-settled transactions. This followed concerns that companies faced the burden of having to calculate the cost of the share-based transaction for the subsidiary on a basis different from that at which is was measured in the group financial statements.

The ASB has decided not to make an amendment, noting that the benefits of keeping FRS 20 and IFRS 2 aligned outweigh the costs. While an exemption would represent a cost saving for certain companies, it would apply only to the minority of cases where the substance of the arrangement was a grant of options by the subsidiary itself. It would not affect those arrangements where the grant was made by the parent; in such cases there is no additional burden.

Amendment to IFRS 1 ‘First-time adoption of International Financial Reporting Standards – Cost of Investment in a Subsidiary’.

In January the IASB issued the above Exposure Draft (ED) which aims to provide relief from difficulties on first-time adoption of IFRS. IFRS 1 requires the cost of an investment in a subsidiary to be measured in accordance with IAS 27 ‘Consolidated and Separate Financial Statements’. IAS 27 requires that distributions received in excess of post-acquisition profits be recognised as a reduction of the cost of the investment – there is no similar requirement in UK financial reporting standards. As a consequence some UK entities have experienced significant difficulties in restating the cost of investments on transition to IFRS.

The ED proposes that a parent entity may use a deemed cost at the date of transition to IFRS instead of restating its cost in accordance with IAS 27. The IASB considered three options for determining deemed cost, these include:

i.  cost of the investment under previous GAAP;

ii.  the parent’s interest in the carrying amount of the subsidiary’s
       net assets using the carrying
       amounts in accordance with
       IFRS; and

iii.  the fair value of the investment.

The IASB decided not propose option one above, because it considered that it would provide less useful information than the other two methods proposed.

The ASB’s response to the ED welcomes the decision to propose relief. The ASB, however, considers that the root of the problem is the cost method in IAS 27 and would have preferred to see an amendment to IAS 27. The response also asks the IASB reconsider its decision to reject option (i), noting that it considers the proposal to use the previous GAAP amount is consistent with relief in IFRS 1 not to apply IFRS 3 ‘Business Combinations’ retrospectively. The response can be accessed via the ASB's website at: www.frc.org.uk/asb.

Business Combinations

The IASB is continuing its redeliberations of its proposals to amend IFRS 3 Business Combinations and plans to issue a revised standard later this year. The IASB has previously agreed the revised standard will include the principle that all components of a business combination, including non-controlling interests, will be measured at fair value. At its March meeting the IASB agreed a proposed relief from the principle to measure non-controlling interest at fair value, where this would cause undue cost and effort for an entity.