IFRS News - May 2011

Emerging issues and practical guidance

IFRS News — May 2011 (312 MB) Download the PDF version.

In this issue:

• Convergence timetable has shifted
• Leasing and revenue updates

Convergence timetable has shifted

The IASB and FASB announced last month that they are extending the target date for completing their joint priority projects from June 2011 to the end of this year. The target projects are revenue, leases, financial instruments and insurance contracts.

The boards have received significant feedback on each of these projects, and many stakeholders expressed concern over the boards’ ability to deliver high-quality standards by June 2011.

Explaining the reason for the delay in their podcast last month, IASB chairman, Sir David Tweedie, and FASB chairman, Leslie Seidman, emphasized the importance of producing high-quality standards. They also acknowledged the critical role of evaluating and incorporating stakeholder feedback.

Progress report

The boards followed this announcement with a report updating their progress on the convergence agenda. Noteworthy actions since their last progress report, issued in November 2010, include the following:

• The boards are due to complete a number of projects in the next few weeks. Joint standards on fair value measurement and presentation of other comprehensive income will be released shortly. In addition, the IASB will issue new standards on consolidated financial statements (including disclosures), joint arrangements and post-employment benefits.
• The boards continue to prioritize their efforts on the revenue, leasing and financial instrument projects. In addition, they will continue to give priority to their joint project on insurance. The boards are on the same track for revenue and leasing, although their timing may differ for financial instruments and insurance, see below.

Next steps

The next steps for the priority joint convergence projects, as laid out in the progress report, are as follows:

• Revenue and leasing — The boards will consider whether to re-expose the proposals once they finalize their redeliberations. If re-exposure is not considered necessary, the draft standards will be made available via the boards’ websites for review and for consultation with the parties most affected by the proposals. The draft standards will also be subject to a “fatal flaw” review process. The boards will consider the feedback received from these steps and either finalize the standards or consider whether additional work or re-exposure is necessary.
• Financial instruments — The FASB plans to finalize its deliberations on classification and measurement in the third quarter and consider whether re-exposure is necessary. The IASB has already finalized its classification and measurement phase set out in IFRS 9. However, it plans to expose the modified FASB approach to seek views from constituents.
• The IASB will continue to deliberate its hedging proposals over the next few months. The FASB will, meanwhile, participate in the discussions and determine whether to move forward with the new IASB approach to hedge accounting. The FASB’s timing on hedge accounting is not yet clear.
• The boards are working side by side on impairment. They plan to decide on a basic impairment approach in the next couple of months and then consider whether re-exposure is necessary. They also expect to finalize the joint proposals on balance sheet offsetting in the third quarter.
• Insurance — The boards are deliberating the insurance project jointly, but the IASB is a step closer to issuing a final standard. The boards aim to complete their deliberations on the major issues in June 2011, but further discussions are likely to carry on into the second half of 2011. The IASB is planning to release a final standard by the end of 2011. The FASB plans to issue an exposure draft (ED) by the end of 2011, with a view to finalizing the standard in 2012.

Leasing and revenue updates

The IASB and FASB continued discussing the revenue and leasing projects last month. Summaries are provided below.

Leasing

The boards discussed the following key re-deliberation issues.

Definition of a lease

The boards confirmed that a leases is defined as “a contract in which the right to use a specified asset (the underlying asset) is conveyed, for a period of time, in exchange for consideration.” They tentatively decided to revise the guidance for distinguishing a service from a lease. A specified asset will be defined as an identifiable asset as opposed to an asset of certain specificity. The board also agreed that physically distinct portions of a larger asset — for example, a floor of a building — can be a specified asset. Non-physically distinct portions, such as capacity in a pipeline, are not specified assets.

The boards tentatively decided that the description of control should be consistent with the revenue recognition project and include guidance on separable assets. A contract would convey the right to control the use of an underlying asset if the customer has the ability to direct the use, and receive the benefit from use, of a specified asset throughout the lease term.

Variable lease payments

The boards tentatively agreed that variable lease payments that are usage or performance-based would not be considered in measuring the lease asset and liability unless the variable lease payments are, in substance, fixed lease payments. This reverses their tentative decision in February 2011 to include performance and usage contingencies that are reasonably assured to be paid. The earlier tentative decision to include all contingencies that are based on a rate or an index remains unchanged.

Profit or loss recognition pattern — lessees

The boards made a tentative decision that, while all leases would be on the balance sheet, the pattern of profit and loss recognition would be different for those that are financing in nature versus those that are other-than-financing in nature. Finance leases would retain the front-loaded expense recognition pattern in the ED, categorized in two line items: depreciation and interest expense. Leases that are other-than-financing in nature would have a straight-line recognition pattern in the profit or loss, categorized in one line, described as rental expense. It was tentatively decided that, for other-than-finance leases, the liability to make lease payments and the right of use asset should be initially measured at the present value of lease payments. The liability would subsequently be measured using the effective interest method proposed in the ED; however, the amortization of the right-of-use asset would be the difference between the straight-line amount and the interest expense amount, such that depreciation is effectively the balancing figure to obtain straight-line profit and loss recognition. The boards also tentatively agreed that the indicators used to distinguish between these two categories would be the same indicators currently contained in IAS 17, Leases.

Some IASB board members still favour one model for all leases. The staff will, therefore, bring back both lessee profit and loss recognition and lessor accounting for an education session before the next meeting, where both issues will be redeliberated.

Lessor accounting (education session only)

The boards want to bring back two approaches to lessor accounting if a dual lessor model is adopted (one approach similar to the current IAS 17’s accounting for lessors; a second approach similar to the performance obligation approach and derecognition approach in the ED but with a net presentation on the balance sheet where the performance obligation approach is used). They have also asked for the derecognition approach to be brought back for discussion.

Revenue

Last month, the boards reached the following tentative decisions.

Determining the transaction price

The transaction price is the consideration to which the entity is entitled, including variable or uncertain consideration. It is a probability-weighted estimate or the most likely amount of the cash flows the entity expects to receive.

Allocating the transaction price

The transaction price is allocated to separate performance obligations using the relative stand-alone selling price. A residual technique may be used when there is significant variability or uncertainty in the stand-alone selling price of one or more performance obligations.

Variable or uncertain consideration

Revenue is only recognized when the transaction price is “reasonably assured” of being received. It is not recognized when the customer can avoid paying (for example, some sales-based royalties) and when the entity has no predictive experience with similar contracts.

Contract costs

Fulfilment costs are in the scope if they are not addressed by other guidance (for example, set-up costs). They are capitalized if they are directly related to a contract (or anticipated contract), generate or enhance the entity’s resources and are expected to be recovered.

Licences

There is no distinction between exclusive and non-exclusive licences. Licences are evaluated using the same principles as other items based on when the customer obtains control.

Customer put options

Arrangements where a customer can require the seller to repurchase an asset are accounted for as a lease if the arrangement represents a right to use the asset over time.