IFRS News — May 2008

Shedding light on the IASB's activities*

		IFRS News — May 2008 (128 KB) Download the PDF version. IFRS News Supplement — May 2008 (80 KB) Download the PDF version. IFRS News Canadian Supplement — May 2008 (81 KB) Download the PDF version.

Canadian Securities Administrators Staff Notice 52-320
On May 9, 2008, the Canadian Securities Administrators (CSA) issued Staff Notice 52-320, Disclosure of Expected Changes in Accounting Policies Relating to Changeover to International Financial Reporting Standards (the Notice). The Notice provides guidance on disclosures that an issuer should be making in its interim and annual management's discussion and analysis (MD&A) relating to the changeover to International Financial Reporting Standards. For 2008, the Notice provides that if an issuer has developed an IFRS changeover plan, the MD&A should include the status of key elements and timing of the plan, which might include the impact on:

• accounting policies, including choices among policies permitted under IFRS, and implementation decisions such as whether certain changes will be applied on a retrospective or a prospective basis;
• information technology(IT) and data systems;
• internal control over financial reporting;
• disclosure controls and procedures, including investor relations and external communications plans;
• financial reporting expertise, including training requirements; and
• business activities, such as foreign currency and hedging activities, as well as matters that may be influenced by Canadian GAAP measures such as debt covenants, capital requirements and compensation arrangements.

As outlined in the Notice, the disclosure requirements become more detailed as the date of changeover approaches and conversion plans progress. Copies of the Notice can be obtained at www.osc.gov.on.ca.

Have you considered the tax implications of the move to IFRS?
The move could affect the measurement and reporting of income taxes for financial statement purposes and the calculation of Canadian taxes payable. The May IFRS News Canadian Supplement considers the possible affects on:

• Financial statements
• Accounting for income taxes
• Computation of taxes payable

Putting IFRS in motion: Are you on track?
Now that the Canadian Accounting Standards Board has finalized its decision to require Canadian publicly accountable enterprises to adopt IFRS as Canadian GAAP,starting in 2011, what's next for your company?
To help you understand the background and context behind the decision to adopt IFRS in Canada, and the key strategic issues you'll face in converting to IFRS, read "Putting IFRS in motion: Are you on track?" To view this and other IFRS publications visit www.pwcifrs.ca.

• Reducing complexity in reporting financial instruments -Part 2
• Post-employment benefits DP
• IASB member Zhang Wei-Guo
• India moves to full IFRS
• IFRS News Canadian Supplement — May 2008
• IFRS News Supplement — May 2008
  • Credit crunch and related market turbulence: Practical implications for preparers of financial statements
  • Economic crisis: IASB told to improve guidance
  • Viewpoint: Can the IASB do more?
  • Top ten impairment issues
  • Effect on employee benefits accounting
  • Accounting issues arising from the "credit crunch"

Reducing complexity in reporting financial instruments -Part 2

The IASB issued a discussion paper Reducing Complexity in Reporting Financial Instruments, in March 2008. It is the first step toward a new standard for reporting financial instruments that is principle-based and less complex than the current requirements under International Accounting Standard (IAS) 39. Part 2 of the article looks at the IASB's proposal that fair value is the only measure appropriate for all types of financial instruments. Jessica Taurae of the Global ACS Central team considers that proposal.

The discussion paper asserts that complexity in financial instrument accounting is driven by different measurement attributes. Moving to a single model is, therefore, the IASB's suggested way to reduce complexity. The last section of the discussion paper sets out the IASB's arguments as to why fair value is the only measure appropriate for all types of financial instruments. It sets out some concerns about using fair value to measure financialinstruments in some circumstances. It also raises issues that need to be addressed before fair value measurement of financial instruments can become a general requirement.

Fair value: The only measure appropriate for all types of financial instruments?
The IASB acknowledges that arguments can be made for measuring some types of financial instruments differently but concludes that fair value is the only measurement attribute suitable for all types of financial instruments. Measuring all types of financial instrument using a cost-based method is not a feasible alternative. For example, it is widely accepted that the cost of a derivative does not provide users of financial statements with information about future cash flows.

To explain its view, the IASB has compared instruments with highly variable cash flows with those with fixed or only slightly variable cash flows. The IASB considers all derivatives (including interest rate swaps) to be instruments with highly variable cash flows. It argues that fair value is the only relevant measure for derivatives because the initial cash flows for a particular instrument are not highly correlated with ultimate cash flows and therefore cost-based measures have little or no relevance for assessing future cash flows. Future cash flows are correlated with the initial cash flows for instruments with fixed or only slightly variable cash flows (such as debt instruments) when the instrument is held tomaturity and credit risk is low. Low credit risk makes cash flows highly probable. The discussion paper acknowledges that, for those instruments, accreted cost is a feasible alternative to fair value and provides some relevant information to users.

Counter-arguments given in the discussion paper for the use of fair value for instruments with fixed or only slightly variable cash flows, include:

• having a single measurement method for all types of financial instrument would eliminate any confusion about the measurement of different financial assets;
• there would be no requirement for when and how to quantify impairment losses;
• fair value better reflects the price of a financial asset that would be received if an entity needed to sell an asset at the balance sheet date. The information is useful even if management has no plans to sell the asset;
• for financial assets: it provides information about anticipated future losses, not just losses that have been incurred;
• for financial assets: it provides information about improvements in credit risk since origination or acquisition;
• for financial liabilities: entities with comparable credit ratings and obligations will report liabilities at comparable amounts;
• for financial liabilities: fair value would result in an entity reporting the same measure for two equally secure payment obligations with identical cash flows; and
• fair value better reflects the cash flows that would be paid if liabilities were transferred at the measurement date.

Concerns about the fair value measurement of financial instruments

Three main concerns about fair value measurement of financial instruments are discussed: the relevance of a reported change in fair value; why should unrealized gains and losses affect profit or loss; and the difficulty and uncertainty in estimating fair values of financialinstruments when no market-based information is available.

The key concern about the relevance of reported change in fair value results from the volatility that arises in profit or loss. Concerns have been raised that the volatility in profit or loss arising from factors beyond management's control should not be reported, as the volatility is caused by market forces.

The second concern is whether unrealized gains and losses in profit or loss can be misleading. The discussion paper considers:

• whether the information is sufficiently objective and reliable;
• what use is the information about gains and losses that may never be realized;
• why recognize an unrealized gain or loss on a financial liability when an entity's obligation is unchanged; and
• why recognize unrealized gains on financial liabilities when an entity's financial position worsens?

The third concern relates to the difficulty and uncertainty in estimating fair values when no market-based information is available. This will often require the use of valuation and other non-accounting experts who may not be widely available in some jurisdictions. It also acknowledges that judgment will be required by preparers in estimating fair values and that the requirement to measure all financial instruments at fair value will exacerbate these difficulties.

What remains to be done before fair value measurement is required?
The last section of the discussion paper highlights four main issues that need to be addressed before fair value measurement for financial instruments can become a general requirement.These are:

• Presentation: How should the effects of changes in fair values be presented in profit or loss?
• Disclosure: What information about financial instruments should be disclosed?
• Measurement: What is the definition of fair value and how should fair values be measured?
• Scope: What is the appropriate definition of a financial instrument?

Which financial instruments, if any, should be outside the scope of a standard for financial instruments?

Full fair value for all financial instruments?

The discussion paper is an interesting contribution to the debate on fair values in the marketplace at the moment. The timing of moving to a full fair value model would be a key consideration to any decision as would the following:

• The IASB has already identified that it needs to define fair value and how fairvalues should be measured. Without knowing what fair value means, it is difficult to conclude on its appropriateness.
• There is a need to consider the objectives of financial reporting and, in particular, whether the impact of current market conditions on fair values really helps users' analysis of issued debt or an asset that will be held to maturity.
• On that note, what do users want? Members of the Corporate Reporting User Forum (CRUF)¹ stated that fair value is a good idea but that an extra layer of information on cash flows that would be useful.
• Are valuation models sufficiently robust? The Financial Stability Forum² has requested the IASB to undertake a project to improve its guidance on determining fair values, particularly, when markets are no longer active. The IASB has been requested to form an expert advisory panel to assist them with this. It would be imprudent to push ahead with a full fair value model without the results of this analysis.
• Is any single number meaningful on its own? The world's leading regulators and supervisors³ have all stated that transparency is key to understanding fair values and that the quality of disclosures about valuations, valuation methodologies, price verification process and the uncertainty associated with valuations must be enhanced. So a move to full fair value should be accompanied by more meaningful disclosures.

Post-employment benefits DP

The IASB issued a discussion paper in March 2008 proposing the first stage of improvements to post-employment benefit accounting under IAS 19. The proposals represent a radical change to pension accounting for companies with defined benefit plans. Richard Davis explains:

The IASB's intention is to improve the reporting and presentation of defined benefit plans. It also wishes to address perceived problems for plans that fall somewhere between defined benefit and defined contribution. The proposals create another category - contribution-based plans - with specific recognition and measurement requirements, but they leave the requirements for defined benefit and defined contribution plans untouched.

Reporting and presentation
Some argue that getting rid of the deferred recognition options allowed under IAS 19 is overdue and a much needed fix to ensure a meaningful balance sheet - in particular, thecorridor/spreading approach to recognition of actuarial gains and losses. The Financial Accounting Standards Board (FASB) addressed this issue as a quick fix in Statement of Financial Accounting Standards (SFAS) 158, before starting a wider-ranging and possiblyprotracted debate as phase 2 of its considerations.

Others argue that recognizing in the income statement an assumed rate of return on assets, irrespective of what the actual return is, does not reflect reality. Looking back to the falling markets that followed the "dot-com boom," some companies recognized income with anexpected rate of return that was greater than their disclosed profit for the year, even though their investments were dropping in value. In other words, the market value of investments was falling but income was being recognized for the expected return. The difference betweenthe actual (negative) and expected (positive) returns was deferred as an actuarial loss.

If we accept the premise that smoothing tools are not appropriate, where in the performance statement should the resulting (potentially volatile and large) pension expense be recognized? The alternatives under the current IAS 19 are either all through profit or loss, or actuarial gains and losses through the SoRIE and everything else through profit or loss.

The discussion paper proposes three alternative approaches:

Approach 1
Everything is recognized in profit or loss.

Approach 2
The interest cost, actual return on assets and changes in the discount rate are recorded in other comprehensive income (SoRIE), and everything else in profit or loss.

Approach 3
The impact of changes in the discount rate and the difference between the actual return on plan assets and a (to be determined) measure of income on plan assets are recorded in othercomprehensive income and everything else in profit or loss.

These alternatives reflect two principles:

• there is a natural offset between the unwinding of the discount on the value of the liabilities and the return on plan assets set aside to match those liabilities, so the interest cost and at least some part of the investment return should be in the same part of the performance statement; and
• there is a difference between changes in the value of the liability (which arise from the present value approach, i.e. interest cost and changes in the discount rate) and changes in the estimate of how much benefit will be paid (mortality, turnover and salary or pensionincreases).

These proposals would put more of the components of pension expense into profit or loss than the current SoRIE approach. Whether this would increase or reduce the profit or loss is another question, which depends on how good actuaries really are at predicting the future.

Contribution-based plans
The truly radical part of the proposals is the introduction of a new classification, contribution-based plans, and the use of a fair value measurement approach for these plans. The definition of contribution-based plans encompasses the current defined contribution plansand many other plans that are currently considered defined benefit. The introduction of a fair value measurement model also allows the standard to reflect the economics of plans that base their benefits on the higher of two alternatives.

The premise behind contribution-based plans is that there are many benefits that can be expressed in the form of a contribution, for example, a percentage of current salary or fixed amount, plus some form of indexation or return, for example, the actual return on a pool ofassets or a stock market index or the movement in an index of consumer prices. The benefit earned in any year does not depend on future salaries. Consider a pension scheme where the benefit is a lump sum equal to contributions of 5% of salary each year plus the return on a stock market index.

If the contributions are invested in an index tracker fund through a pension fund, the plan would currently be defined contribution. If the contributions are not invested in pension plan assets that guarantee the promised return, the plan would currently be defined benefit. Theproposals would classify such a benefit promise as a contribution-based plan, no matter how the contributions are invested.

The proposed measurement approach for contribution-based plans is to attribute the benefits in line with the benefit formula and then measure the obligation at fair value assuming the terms of the benefit promise do not change.

Going back to the example scheme above, the treatment for the defined contribution plan should not change. However, for the unfunded plan, instead of using a projected unit credit valuation with a high-quality corporate bond yield discount rate, management would usefair value assuming the terms of the benefit promise do not change. What does this mean in practice?

The unfunded promise will only be paid if the company is still solvent when the benefit falls due, so the fair value should reflect the default risk inherent in the promise. In principle, that should be the credit risk of the employer, depending where the pension benefits would fit in the order of priority on any winding up.

This is a major change from current IAS 19. The measurement of the same benefit promise today for two different companies would be the same irrespective of differences in their creditrating or how they choose to finance the benefits. The proposals could lead to wide variations in the values placed on identical benefit promises by different employers.

An example of this divergence also arises when you look at benefits in payment. The measurement bases for defined benefit plans and contribution based plans are different. A pension of €1,000 a year would be measured at fair value if it was from a contribution-basedplan and in accordance with current IAS 19 for a defined benefit plan. The extent of any difference will depend on how fair value is determined; but in many territories where pension plans are funded, pensions in payment are often given highest priority so that the defaultrisk may be very small. If fair value is an exit model, as in SFAS 157, one view is that the cost of buying an annuity from an insurance company is the fair value. The mortality assumptions used by insurance companies in many territories are more conservative, or perhaps less optimistic, than those used by pension funds. Insurance companies often assume that the retiree will live longer and draw more benefits than the assumptions made by the employer.Also, the yields underlying annuity contracts are seldom as high as high-qualitycorporate bond yields. The value placed on a €1,000 per annum pension from a contribution-based plan could be considerably higher than the value placed on the same pension payablefrom a defined benefit plan.

Looking to the future
What follows the revised version of IAS 19 that will result from this discussion paper? Phase 2 of the IASB's review. It is difficult to see that the standard can maintain two models for valuing an identical obligation. This implies that either the measurement model forcontribution-based plans will be relatively short-lived, or defined benefit plans willmove to the same model.

The proposals will have significant impacts on the accounting for many forms of benefit design and could set the framework for benefits accounting for a long time to come. Preparers and users of accounts are encouraged to consider these proposals and respond to the IASB's invitation to comment now, rather than wait for an exposure draft, or even a standard. The comment period ends on September 26, 2008.

IASB member Zhang Wei-Guo

Zhang Wei-Guo joined the IASB in July 2007 as a full-time member. He previously worked as Chief Accountant and Director General of the Department of International Affairs at the China Securities Regulatory Commission (CSRC). He has been involved in accounting standard-setting, auditor oversight, and cross-border regulatory co-operation issues at the CSRC and with the International Organization of Securities Commissions.

What have you found most enjoyable about your role at the IASB so far?
There are two things I particularly enjoy. First, we are achieving much wider adoption and convergence than anyone expected. China has already implemented the converged newaccounting standards. Japan and Korea have announced their adoption or convergence programs. The U.S. Securities and Exchange Commission has waived the US generally accepted accounting principles (GAAP) reconciliation requirements for foreign private issuers and is now seeking the possibility of allowing US domestic companies to use IFRS.

Second, I am working with a very good team, including IASB members and staff from more than 20 countries. They are professional and friendly, and have created a spirit of co-operation.

What do you want to be remembered for from your time at the IASB?
My philosophy is quite simple - try our best to solve issues in the most appropriate way. When someone retires or moves from his or her current position, he or she should be proud of the judgments and decisions that he or she has made. He or she will also hope others will learn from any mistakes he or she made.

What do you see as the most important project on the IASB's agenda and why?
Revenue may be one of the most important projects on the IASB's agenda. Accounting and reporting for revenue was traditionally based on a revenue/expense view (or the incomestatement approach). Now we are moving to an asset/liability view (or the balance sheet approach). It will not only cover income statement items, but also touch many balance sheet items, including the timing of recognition and measurement, as well as presentation and disclosure issues. The IASB's final decision will determine the extent of the possible changes.

Are there any new projects you would like to see added to the IASB's agenda?
We are now in an environment where people have different views. Some want more problems to be resolved to enhance the quality of IFRS and to meet the needs of those countries in adopting or implementing IFRS. Others prefer a stable platform for a period. I think weneed to scrutinize what should be put on the agenda and only put through amendments that are strictly necessary. Preparers, auditors, national standard-setters and others will inevitably raise issues to us, but the IASB needs to be more careful when making this kind of tough decision.

What about the "common control project"? It must be important to China.
It is quite important to China because there are many transactions in listed companies, either government or privately controlled, under common control. This is why the current accounting standards in China on business combinations divide into two parts: one on non-common control transactions, the other on common control transactions. When the IASB sought advice from the Standards Advisory Committee, the members identified this as the number one project to be added to the agenda. To my surprise, many other countries, including those in Europe, also requested to add this project to the agenda. So the IASB did so in December last year. This is a difficult project. I think the IASB has made the right decision to put it onto the agenda. The project will examine the definition of a business combination involving entities or businesses under common control and the methods of accounting for thosetransactions in the acquirer's consolidated and separate financial statements. The IASB also decided to include demergers in the scope of the project because these two issues areoften closely related.

How do you see standard setting evolving over the next five years?
First, more countries will either adopt IFRS or converge with IFRS. Among them, the most important decision is whether the United States will allow domestic preparers to use IFRS.

My second prediction is how the IASB resolves issues from different countries and regions. When IFRS is more and more widely used and strictly enforced, the result will inevitably be more questions from around the world. The IASB will face some challenges from different regional issues.

Third, the IASB has to make a trade-off between expected stability and required changes to the standards.

The views expressed in this article are personal and not necessarily those of the IASC Foundation or the IASB.

India moves to full IFRS

India announced in July 2007 its plan to converge fully with IFRS by 2011. The announcement has been widely welcomed. Sanjay Hegde, the head of PwC's Capital Markets Group in India, talks to IFRS News about preparations.

What has happened since the Institute of Chartered Accountants of India (ICAI) announced that India would align its accounting standards to IFRS?
The prerequisite for achieving convergence successfully is to lay down the strategy. This includes a roadmap for achieving convergence in a systematic and consistent way, keeping in view India's legal, economic and other peculiarities.

The ICAI, which regulates the accounting profession in India, has embarked on its IFRS convergence exercise in earnest. The 2011 deadline allows us plenty of time (deliberately so).The Accounting Standard IASB (ASB) of ICAI was entrusted with the responsibility of preparing the "Concept Paper on Convergence." The paper's objective was to: (a) explore theapproach for achieving convergence with IFRS, and (b) lay down a detailed road map. The ASB set up a task force comprising of members from different backgrounds - industry, profession, training, government, IASCF Trustees and others. The concept paper, including the road map, was published in the second half of 2007. It outlines the objectives, roles, responsibilities, strategy and action plans.

Will accounting prepared under Indian IFRS qualify as "full IFRS," or will there be differences? If different, what will this mean for Indian entities?
The ICAI considered whether: (a) the existing Indian Accounting Standards should be revised to make them fully compliant with IFRS; or (b) the IFRS, including the IFRS reference numbers, should be adopted from April 1, 2011.

The ICAI believes that it would be more cumbersome to follow the first approach, and has therefore chosen option (b). The IFRS will be issued as "Indian AS," which will be IFRS-equivalent. The existing accounting standard reference number will be given along with the IFRS number.

As far as the legal and regulatory aspects are concerned, the ICAI has decided that where there are conflicts between IFRS and Indian laws/regulations, the latter will prevail. The ICAI believes that this approach is appropriate because it would not be practicable to postpone fullconvergence until the relevant laws/regulations are amended, as such amendments may not take place for many years.

For example, AS 21, Consolidated Financial Statements, defines control as ownership of more than one half of the voting power of an enterprise or control over the composition of the governing body of an enterprise. This definition is largely based on the definitions of holding company and subsidiary company as per the Companies Act, 1956. However, IAS 27, Consolidated and Separate Financial Statements, defines control as "the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities."

Therefore, until the corresponding amendments are made to the Companies Act, there would be ambiguity and so the current regulations would prevail. The task force has also stratified the target companies into two groups: public interest entities (PIEs) and small and medium enterprises (SMEs).

PIEs include all companies:

a) whose equity or debt securities are listed or are in the process of listing on any stock exchange, whether in India or outside;
b) that are banks (including co-operative banks), financial institutions, mutualfunds or insurance entities;
c) whose turnover (excluding other income) exceeds rupees 1 billion in the immediately preceding accounting year;
d) that has public deposits and/or borrowings from banks and financial institutions in excess of rupees 250 million at any time during the immediately preceding accounting year; or
e) that is a holding or a subsidiary of an entity that is covered in (a) to (d) above.

The ICAI only wants PIEs to become IFRS compliant to start with. It believes that it may be appropriate to have a separate standard for SMEs. But SMEs do not need to adopt the IASB's "IFRS for SMEs," for India to be an IFRS-compliant country.

What has been the response of CFOs, investors, analysts, preparers and others in India?
The announcement was received very positively by one and all, although for different reasons. An independent survey conducted in India found that 95% of CFOs of large Indian companies are interested in swiftly converging with global accounting standards, mainly IFRS.

How prepared are Indian entities for the transition to IFRS?
That is difficult to answer. In any such large-scale transformation there are always different challenges at different stages. And different companies are placed differently to tackle those challenges. For example, a company that has a foreign parent and has been reporting under IFRS or parent company GAAP for some time would probably find it relatively easy to transition to IFRS; but a company doing the transition from Indian GAAP to IFRS would find it tougher, particularly, regarding the concepts related to fair value, investment property, business combinations and derivatives.

Current Indian GAAP, although styled on IFRS, deviates from it for various reasons - for example, maintaining consistency with the legal and regulatory requirements, the economic environment, levels of preparedness and conceptual differences - although the aim has always been to follow IFRS, to the extent possible, while formulating the Indian Accounting Standards.

However, one refreshing and positive aspect in India's case is the willingness to move to IFRS and the acceptance of the inevitable change. That could be a differentiating factor between the transition story in India, compared with other countries. In fact, unlike theexperience in other transitioning countries, many companies in India might go for a "strategic approach" to adopting the standards. Given India's IT strength, companies may embed thesystems along the way, rather than first converging to IFRS and then embedding or taking a tactical approach where high-level differences are identified and plugged, mostly on spreadsheets.

That said, it will take time to embed the requirements in systems and the business so that the management information systems, the accounts and the huge amount of disclosures can begenerated readily and reliably.

What will be the biggest change for entities reporting under IFRS?
There will be many big changes, but if I have to pick one, I believe it will be the fair value accounting, be it IFRS 3, IAS 39, IAS 40 or IFRS 2, etc. All of these pose a challenge, not only because of the mindset (of the accounting professionals in industry and in practice) of prudence and cost-based accounting; but also, we will be asked questions like, "Why fair value? It couldn't prevent an Enron or a sub-prime situation in the world's biggest economy with the deepest and safest securities markets."

From a presentation and disclosure perspective, Indian companies are accustomed to following Schedule VI of the Companies Act of India with its standard presentation and disclosures. This will be a significant change for companies in their transition to IFRS.They will have to assess for themselves the various disclosures and presentations required for their company, especially, considering IFRS 7, Financial Instruments: Disclosures, which is already proving to be a challenge for companies across the world. IFRS 7 will be really demanding for banking and financial companies in India, which have traditionally reportedfollowing norms set by the Reserve Bank of India, ICAI, Companies Act and Banking Regulation Act and IAS 39. This is not only because of the derivatives accounting, impairment reserve calculations and the requirement to carry most of your investments at fairvalue, but also because of the rigorous disclosures it requires. The data required for such disclosures will be substantial, as are the data points with which they are captured. Indian companies are not geared up for that at present and will find this a significant challenge.

What about IFRS 3R?
As mentioned above, we believe that different entities will find different standards a challenge to apply. However, in the international context, the accounting standards that are extremely relevant today, particularly in light of cross-border and domestic deals, are the standards on business combinations (IFRS 3) and consolidated financial statements (IAS 27 and SIC-12).

There is no comprehensive guidance available currently in Indian GAAP that addresses the accounting for special purpose vehicles. Professionals look to AS 21, Consolidated Financial Statements, which lays a lot of emphasis either on majority equity stake or majority representation at the IASB when defining control. This will be difficult under IFRS, which has stricter guidance on interpreting control: "The power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities."

Companies moving to IFRS in India will have to think about their SPE structures and check whether they should be consolidated or not. In most cases under IFRS, SPEs will qualify forconsolidation, affecting the balance sheet and the results of operations. Specifically, financial services companies may find their capital adequacy ratios impacted.

Another challenge will be the requirement to perform a fair value based purchase price allocation in a business combination. Indian GAAP requires a book value based goodwillaccounting.

However I would like to emphasize that with clarity as to the approach and objectives and determination of the purpose, India is moving steadily but surely toward achieving goal of convergence with IFRS by 2011.

IASB Project timetable and IFRIC project timetable (20 KB) Download the PDF version.

IFRS News Supplement - May 2008

Credit crunch and related market turbulence: Practical implications for preparers of financial statements

The challenging market conditions continue. We are seeing big writedowns and writeoffs in the financial services sector. The markets continue to be volatile, and central banks are injecting liquidity into debt markets. But these conditions and theirconsequences, including the almost unprecedented lack of trust that has been and stillis evident in the interbank markets, have an impact beyond the banking and financialservices sector. Leader of PricewaterhouseCoopers' Global Accounting Services,Richard Keys, explains:

The market conditions are most immediately felt by those fair valuing financial instruments. Fair value in accounting has come under attack from some quarters accused of making the problems worse. Fair value is not perfect, but most agree it is a more relevant measure than historical cost for financial instruments. What needs further attention is how fair value is applied in illiquid markets and how and when models should be used for its determination.

Any balance sheet measurement is most relevant at the balance sheet date. Fair value information can only provide a fix on value at the point in time it is measured. While it is likely to be the best indicator available, its relevance will also depend on, among other factors, the volatility of the market inputs and whether the instruments valued are actively traded or are held for the longer term. What it does provide is an important indicator of risk profile and exposure, but to fully understand this and put it into the context of a particular business requires further and more specific disclosures. It is going to be important to examine whether the first-time adoption of IFRS 7 in 2007 has facilitated this better understanding and context or has resulted in just another set of information disclosures from which it is difficult to distinguish the "forest from the trees."

All companies need to account for the effect of the recent economic turmoil on the business. The accounting should not get in the way of management's strategy for coping with market conditions. But management needs to start thinking about disclosure and informing the market about how it is handling the tough conditions. It should also be thinking about how different parts of the business are affected: the market inputs it uses in impairment testing, the implications for employee benefits, hedge effectiveness and other issues around financial instruments. This supplement addresses all these areas and offers practical guidance on the actions management can take.

We all have to take into account the credit crunch and volatility "game." There is no choice.

Economic crisis: IASB told to improve guidance

The G7 group of most industrialized nations last month called on the IASB to improve its guidance for off-balance sheet entities in these times of economic crisis.

The G7 finance ministers and Central Bank Governors said in a statement following their meeting in Washington last month: "The IASB… should initiate urgent action to improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly, on valuing financial instruments in periods of stress."

It also urged the IASB, as well as the Basel Committee, The International Organization of Securities Commissions (IOSCO) and the Joint Forum, to "accelerate their timetables of work to conclude their efforts by end-2008."

The IASB has begun a standard-by-standard review of fair value measurement. The project team is also creating an informal valuation advisory group to provide practical input about measuring fair value and about valuation issues generally.

In addition, as one of the responses to the Financial Stability Forum (FSF) recommendations, the IASB is putting together an advisory group to help address in particular the issue of valuing financial instruments in illiquid markets.

In response to the FSF recommendations, the IASB is accelerating the derecognition and consolidation projects. In the case of the consolidation project, it is issuing an exposure draft without first publishing a discussion paper and is proposing the same for its project on derecognition. However, the IASB underlines that "whilst there is a clear need to make swift progress with these projects, this has to be balanced with maintaining appropriate due process and public consultation."

Sir David Tweedie, chairman of the IASB, said on the conclusions of the FSF: "We are supportive of the recommendations set out in the FSF report and will work with others to ensure that any lessons to be learnt from the crisis are dealt with appropriately."

The IASB and the other multilateral organizations are to provide an update at the next G7 meeting in June 2008. The FSF, which produced the report for the G7 on the contributing factors to the recent turmoil in the financial markets, has also been asked to produce a comprehensive follow-up report later in the year.

Other issues identified in the FSF report and termed "immediate priorities for implementation within the next 100 days" by the G7 include:

• companies' prompt and robust disclosure of risk exposures, writedowns and fair value estimates for complex and illiquid instruments in upcoming mid-year reporting;
• strengthened capital positions and risk management practices, including rigorous stress-testing, overseen by supervisors;
• revised liquidity risk management guidelines from the Basel Committee by July 2008; and
• a revised code of conduct for credit rating agencies from IOSCO.

Viewpoint: Can the IASB do more?

The chairman of PricewaterhouseCoopers' Corporate Reporting Task Force, Roger Marshall, talks to IFRS News about the G7 recommendation that the IASB improves its guidance for off-balance sheet entities (see pX). The views expressed below are his own.

Are the G7's concerns that current IASB guidance is inadequate in times of economic crisis well-founded?

The current accounting model is not ideal. The IASB (in its recent discussion paper Financial Instruments: A Replacement of IAS 39 Financial Instruments: Recognition and Measurement) is looking at improvements in the area of financial instruments that can be made both in the long- and short-term. Its long-term goal appears to be to fair value everything. Certainly fair values are frequently the best measure - for example, of derivatives or financial instruments traded in active markets. However, I don't believe the IASB has fully addressed the difficulties around fair valuing many financial instruments, which are rarely if ever traded.

Preparers already struggle to come up with meaningful fair values on some instruments once a quarter let alone once a month and do not use this information for decision-making purposes. Given the number of practical and conceptual difficulties, I see fair valuing everything as a long way in the future.

Part of the current difficulties stem from the complexity of the current standard, which is caused in part by the significant anti-abuse provisions. I think the IASB focuses too much on anti-abuse measures. There is a concern that these rules also distort presentation. It's always a balance, but I believe the current standard is too far tipped toward anti-abuse concerns.

It would be useful to users of financial statements if companies could provide analysis of where a financial instrument's fair value is "real" (i.e. based on observable market prices) compared with where models have been used. US GAAP already requires this. I also believe that more guidance on fair valuing financial instruments in thin or completely illiquid markets would be welcome. Some preparers are concerned about valuing assets at fire sale prices, which they do not consider impaired and are not proposing to sell; I think these concerns are legitimate.

What can the IASB do to address the G7/FSF's concerns? Should they attempt to fix the accounting?

As noted above, there are things the IASB could do in giving guidance on valuing illiquid instruments and increasing disclosures. However, in general, I don't believe changing the accounting standards is the appropriate way to deal with each year's economic problems. The IASB has a long due process and cannot respond in a timely way to urgent issues. What is more, anything that is agreed would be enshrined in the accounting standards for years; next year, there will be a different issue that needs addressing, and we will end up having more and more disclosure requirements about yesterday's issues.

We are almost halfway through the year. By the time IASB can implement any measures, it will be so late in the year, putting preparers and auditors under a lot of pressure. Even additional mandatory disclosures can be onerous, as IFRS 7 showed. The IASB, therefore, needs to be careful when coming up with new requirements and needs to avoid knee-jerk reactions.

Looking forward, I wonder whether it is the securities regulators that are best placed to respond to such short-term issues. They can mandate the disclosures they require from companies listed on their exchanges. This could be done much more quickly than changes to the financial reporting standards, and the requirements can be removed easily when they are no longer necessary. IOSCO's mandating a common disclosure platform would ensure that global comparability wasn't compromised.

Is more disclosure by companies going to help users?

More disclosure about holdings of financial instruments and about the extent of model-based valuation is helpful, but where should management put that disclosure? Are the financial statements always the most appropriate place? The financial statements are already so complex that they have ceased to be a communication tool to normal investors. I think sometimes the company's website is more suitable. Management can reassure the shareholders with additional disclosure and can update it regularly, rather than being tied to the annual reporting timetable. There is an opportunity for PwC to provide assurance on this information; increasingly, I believe, assurance will be provided on such time-sensitiveinformation rather than only once or twice a year.

I think that minimum disclosure in the financial statements should be mandatory, but I don't think a mandatory format for detailed disclosure will always enhance users' understanding.

What could a well-governed company do to respond to this without there being a change in the standards?

Many companies have already provided significant additional disclosures to their shareholders to address specific concerns. Those that do not should not be surprised at having a higher cost of capital.

Top ten impairment issues

The last 12 months have been marked by increasing volatility in global markets and signs of economic downturn. Management may experience significant impairment charges in the coming months. Olivier Scherer, Caroline Woodward and Dave Walters from PwC's Global Accounting Consulting Services have compiled a list of the top ten areas to watch out for. They have ranked them in reverse order of importance, working up to their top tip!

10. Start impairment testing early
The impairment test process takes time. It includes identifying impairment indicators, assessing or reassessing the cash flows, determining the discount rates, testing the reasonableness of the assumptions and benchmarking the assumptions with the market. The process has to begin early - don't leave it until the last minute, as no one likes nasty surprises. Goodwill does not have to be tested for impairment at the year-end; it can be tested earlier. But if any impairment indicator arises at any balance sheet date, the impairment assessment has to be updated.

9. Comply with the disclosure requirements
IAS 36, Impairment of Assets, and IAS 1, Presentation of Financial Statements, have many disclosure requirements. Market regulators around the world have spotted that some companies are not including all the required disclosures. For example, don't forget to disclose discount rate and long-term growth rate assumptions in a discounted cash flow model for both value in use and fair value less cost to sell; and describe what the key assumptions are and what they are based on. Sensitivity analysis is also even more relevant when the markets are volatile. There is no exemption from disclosures.

8. Allocate goodwill to the appropriate CGUs
When goodwill is acquired, it needs to be allocated to all the cash-generating units (CGUs) or groups of CGUs expected to benefit from the acquisition. These may include CGUs in the existing as well as the acquired business. Think about how the goodwill is going to be subsequently tested for impairment before finalizing the allocation process.

7. Watch foreign currency cash flows
Estimate future cash flows in the currency in which they will be generated. They should be discounted using a discount rate appropriate to that currency.

6. Compare like with likeMake sure the cash flows being tested are consistent with the assets being tested. Watch for consistency when including or excluding working capital from the CGU. Also make sure that the forecast cash flows make allowance for investment in working capital if the business is expected to grow.

5. Reconcile the conclusion to the current environment
When you've finished your detailed calculations, check that the final answer makes sense by comparison to any market data (e.g. share prices and analysts reports).

4. Pay attention to market capitalization
Market capitalization below net asset value is an impairment trigger, and calculations of recoverable amount are required. If the market capitalization is lower than a value-in-use (VIU) calculation, challenge the VIU assumptions. For example, the cash flow projections might not be as expected by the market, and the reasons for this must be plausible.

3. Scrutinize the discount rate
Watch out for illogical discount rates. Interest rates set by governments are falling in many territories, but other factors affect discount rates in impairment calculations. These include corporate lending rates, cost of capital and risks associated with cash flows, which are all increasing in the current volatile environment and can potentially result in an increase of the discount rate.

2. VIU must comply with the standard
In a VIU test, the cash flows exclude the costs and benefits of future reorganizations (unless the reorganization has been provided for in the accounts under IAS 37) and also the costs and benefits of future enhancement capital expenditure. This means the cash flow forecasts for a VIU test may differ from the cash flows in the IASB-approved budgets for futureyears.

1. Cash flows in the impairment calculations must be reasonable and supportable
Forecasts prepared months ago (before the full effects of the downturn became clear) may need to be revised. Forecasts need to be based on the latest management-approved budgets or forecasts, but these do need to be reasonable and supportable. For example, they should be consistent with analysts' forecasts for the sector and the views of other third party experts and economic forecasters.

Effect on employee benefits accounting

The credit crunch and other current market conditions don't just have an effect on assets; they also impact the measurement of employee benefits. Richard Davis explains:

Pensions
IAS 19 requires post-employment benefits to be valued using a discount rate based on high-quality corporate bond yields (at least where there is a deep market). In territories where there are deep markets in high-quality corporate bonds, we are used to seeing charts that plot duration against yield with only a few outliers and maybe a range of plausible yield curves; however, the range of credible answers has been relatively narrow. This year, the same charts are more scattered, with a spread measured in hundreds of basis points rather than tens. When you examine the details, you find that the higher yielding bonds are all financial institutions. The bonds are still rated AA by the credit agencies, but the markets seem to take the view that some AA-rated bonds are not as high quality as others.

Where does this leave preparers and auditors when it comes to setting and auditing discount rate assumptions? There are two main issues:

• the methodologies that have been used in the past to set assumptions may not be robust enough to cope with current circumstances; and
• the range of assumptions that can be reasonably justified, both in absolute terms and without being inconsistent with past practice, is going to be wider than at any time since IAS 19 (revised 1998) (or for that matter SFAS 87) was introduced.

On the positive side, increases in bond yields and, hence, discount rates mean reductions in liabilities, all other things being equal. Therefore, unless the assets have fallen more than the liabilities, the net liabilities are likely to have fallen.

Share-based payments
The parameter that most impacts the fair value of share options is the assumption regarding future share price volatility. The difficult part is estimating what share price volatility might be over future periods - potentially as long as ten years, or more in some territories. Practice in the United States has allowed a safe harbour for two methods:

• implied volatility based on traded options with a life of at least one year; and
• historical volatility considered over a time period equal to the expected life of the option.

IFRS does not give the same automatic approval to these answers; however, in practice, it will often be used to assist the choice of valuation assumptions. The guidance in IFRS 2 and SFAS 123R suggests that when looking back at past volatility, to estimate the future it would be acceptable to ignore temporary periods of exceptional volatility caused by some specific event that will not be repeated. The question is, how do we know certain circumstances won't be repeated?

An event that impacts the whole market might come along infrequently, but if we ignore the periods of greatest turbulence, we will have underestimated volatility at some point. On average, our assumptions will be less than the market experience. This year it is the credit crunch; in the past, we have seen the "dot-com boom," terrorist threats, war and "oil shock" among others. We might not know what the event will be, but it is likely that something will destabilize the market sometime.

One view is that stability is self-defeating - a stable period in markets encourages investors to take greater risks, greater risks lead to instability. For a company that has used implied volatility to determine its assumption, current market conditions may mean that the anticipated volatility over the next 12 months is greater than over the next five years. This approach may therefore no longer be valid. Predicting the future is never easy, and current conditions exacerbate this ensuring that any assumptions being made will come under closer and more critical scrutiny than they might have in the past few years.

Accounting issues arising from the "credit crunch"

Many people around the world are continuing to feel the impact of the credit crunch. As entities approach their interim reporting, they should be alert to some of common issues we have seen recently under IFRS. Jessica Taurae explains:

Fair value
The illiquidity in some markets continues to lead to difficulties in establishing the fair value of some financial assets and financial liabilities. The best evidence of fair value under IAS 39, Financial Instruments: Recognition and Measurement, is quoted prices in active markets. Where these are not available, entities use valuation techniques to estimate the fair value. A valuation technique must incorporate all factors that market participants would consider in setting a price. Determining fair value, therefore, requires consideration of current market conditions, including the relative liquidity of the market and current credit spreads. Entities cannot ignore current information about how the market would price the instrument nor should entities use information that is available post the balance sheet date to update their fair value estimates. In addition, if an entity is looking to place reliance on a fair value provided by a third party (for example, a broker quote or pricing service), it needs to understand how the third party has derived that valuation and whether it is in accordance with the requirements of IAS 39 (e.g. Does it represent actual transaction prices or just indicative prices?).

Impairment of financial assets
IAS 39 focuses on having objective evidence of impairment before a loss can be recognized. Companies will need to consider whether current market conditions imply there is objective evidence of impairment for their financial assets. Loans to sub-prime customers or loans to other entities with sub-prime exposures will have objective evidence of impairment as those customers default. However, if an entity has available-for-sale (AFS) debt securities whose fair value has decreased, perhaps significantly, because of illiquidity and rising interest rates, that on its own is not considered objective evidence of impairment for AFS debt securities under IFRS. If there is objective evidence of impairment of an AFS debt investment, the amount of the impairment loss recognized in profit or loss includes the whole of any cumulative loss previously recognized in equity. This will include any fall in fair value below amortized cost and is not limited to the impairment loss that would have been recognized had the asset been measured at amortized cost. In addition, given the current lack of liquidity, entities may be experiencing shortages of cash. This may lead to trade receivables being doubtful or bad debts, as often it will be the suppliers that are paid last in these times.

Embedded derivatives
The value of some embedded derivatives may previously have been determined to be immaterial, in particular, if the underlying was linked to an event considered to be remote (such as a large change in credit spreads). Companies should be alert to the possibility that the value of such embedded derivatives may have become material as a result of recent market events. For example, many companies had previously concluded that value changes in the embedded credit derivative in synthetic collateralized debt obligations were immaterial and, therefore, had not accounted for them. Under current market conditions, the embedded derivative's fair value is now more likely to be material, in which case that change in fair value must be reflected in profit or loss.

Consolidation of SPEs
Companies with exposure to special purpose entities (SPEs) that have not previously been consolidated under SIC-12 should be alert to the need to reconsider the consolidation decision - for example, if the funding or capital structure of as SPE is amended, this triggers a reassessment of who should consolidate it under SIC-12. This includes the case where acompany (for example, the sponsor, or entity that set up the SPE) steps in to support an SPE when it had no previous contractual obligation to do so.

Reclassifications
In response to current market conditions, it has been suggested that fair value accounting be suspended or changed for certain financial instruments, or that businesses should apply their own models, which may show a less volatile long-term scenario. However, IAS 39.50 prohibits the reclassification of a financial instrument into or out of the FVTPL category while it is held. Accordingly, it is not appropriate to reclassify financial instruments out of the FVTPL category as a result of recent market events.

Hedge accounting
Companies may be experiencing some hedge ineffectiveness as a result of recent market conditions. For example, if entities had designated fair value hedges of fixed rate assets using interest rate swaps, ineffectiveness may arise due to the repricing of the floating leg of the swap. If entities had not designated their hedged risk carefully, they may have hedge ineffectiveness arising from changes in credit spreads that are not mirrored in the hedging instrument. Others that have hedged forecast debt issuances, including the rollover of commercial paper, will need to ensure that the hedged debt issuance is still highly probable of occurring. If not, the criteria for hedge accounting are no longer met, and the hedge accounting should cease.

Disclosures
IAS 34, Interim Financial Reporting, governs the requirements of interim reporting under IFRS. Current market events are likely to require a number of additional disclosures such as:

• further deterioration of the credit exposures reported in the annual financial statements that resulted in the accounting of losses that are unusual because of their nature, size or incidence;
• the fact that certain financial instruments have ceased to be traded in an active market during the interim period and that a valuation technique has been used to measure their fair value;
• the use of different valuation techniques (a method of computation) compared to those utilized for the amounts included in the annual results; and
• a significant change in the financial risk management approach of the entity, which would be disclosed under IFRS 7 if the quantitative disclosure of the entity's exposure to financial risks and its sensitivity to market risks reported at the end of the financial period is not representative of its exposure and sensitivity during the period.

In addition, the FSF¹ recently encouraged entities to make robust qualitative and quantitative risk disclosures, as set out in a supervisory report². Those disclosures cover exposures to instruments that are currently considered to be high risk or involve more risk than previously thought such as:

• exposures to SPEs, distinguishing between those that are or are not consolidated, as well as the nature of the entity's involvement with SPEs and maximum exposure to losses;
• exposures to collateralized debt obligations and a breakdown by underlying collateral (e.g. sub-prime) and related hedging.

In addition, the FSF report requests entities to enhance the quality of their disclosures about valuations, valuation methodologies, price verification processes and the uncertainty associated with valuations. Although not required by IFRS, we strongly encourage entities to provide these enhanced disclosures in the interest of providing greater transparency andin restoring market confidence.