Thursday, March 25, 2010

IASB Chair Reaffirms US GAAP-IFRS Convergence against Backdrop of New IFRS 9 for Measuring Financial Instruments

As a second major wave of IFRS adoptions in Canada, Brazil, Japan and other countries begins this year, IASB Chair David Tweedie said that the convergence of US GAAP and IFRS is proceeding and intensifying. In remarks before the European Union’s Economic and Financial Affairs Council (ECOFIN), Chairman Tweedie also discussed the ongoing replacement of IAS 39 with IFRS 9, a new standard for measuring financial instruments.

As an example of the recently intensified activity between FASB and the IASB, the two Boards are now meeting together every month and have had more than 100 hours of joint meetings since last November. In March, the Boards are meeting jointly for three consecutive afternoons by video, and then for three consecutive days in person in London the following week. These intensive discussions are achieving positive results, said the IASB Chair, and the Boards plan to publish seven joint proposals in the next quarter. The Boards individually will also propose other changes to bring their own standards in line with each other.

Noting that the IASB does not want IFRSs to be a constantly moving target, the Chair said that completing the convergence work in 2011 will provide a period of stability of accounting standards for newly adopting countries, similar to the stable platform given to European companies and investors between 2004 and 2009. He praised the SEC’s recent reaffirmation of the US commitment to make a decision in 2011 to adopt IFRSs by 2015 or 2016.

Turning to the very important work of reforming fair value accounting, the Chair said that the new IFRS 9 on measuring financial instruments addresses the call of the G-20 Leaders to reduce the complexity of accounting standards for financial instruments. This is the first phase of reforming IAS 39.

IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, replacing the many different rules in IAS 39. The approach in IFRS 9 is based on how a firm manages its financial instruments, its business model, and the contractual cash flow characteristics of the financial assets. The Board also decided not to bifurcate hybrids containing embedded derivatives.

The IASB Chair assured that IFRS 9 will not result in an increase in the use of fair value. In IFRS 9, the IASB does not seek to either increase or decrease the use of fair value accounting in overhauling the accounting for financial instruments, he emphasized, rather the goal is to find the right balance and establish appropriate criteria for determining whether to use cost or fair value. The decision depends upon whether cost or fair value provides the most useful information about likely future cash flows. He noted that this is consistent with the business model approach advocated by the European Commission and the Basel Committee.

Under IFRS 9, except in the narrow circumstance where the fair value option is selected by the institution, cost based measurement is required when a financial asset has predictable cash flows and if the objective of the holder is to collect principal and interest over the life of the asset rather than to collect cash proceeds from sale. For a traditional bank that takes deposits and lends money to customers that it holds to collect principal and interest, the IASB expects IFRS 9 to result in fewer items being measured at fair value.

Those concerned about the expansion of fair value seem to be concerned primarily about the potential treatment of financial liabilities. At the suggestion of the European Commission, the IASB removed the treatment of liabilities from IFRS 9. Moreover, the Chair said that the decisions the IASB has made to date for financial liabilities post the publication of IFRS 9 would not result in an increase in the use of fair value in the measurement of financial liabilities.

EU financial institutions raised concerns regarding the decision to prohibit the bifurcation of embedded derivatives on the asset side of the balance sheet. But the IASB Chair said that this was done with the support of the great majority of stakeholders, who viewed the bifurcation as unduly costly and complex. Because the same decision on the liability side may have increased the use of fair value, the IASB retained the bifurcation of embedded derivatives for liabilities.

IFRS 9 does not allow for recycling of realized gains and losses relating to strategic investments when an entity chooses to recognize changes in fair value in Other Comprehensive Income. While both the ECB and the Basel Committee would have preferred the IASB to permit these gains and losses to be recycled to the profit and loss account, noted the Chair, the IASB decided not to allow recycling for two main reasons.

First, recycling distorts current year profits. If you have held an investment for 30 years, reasoned the Board, it is not right to recognize a one-off gain in year 30 just because the investment has been sold at that time. Economically the gain was amassed over the 30 year period. Secondly, this approach would have meant that the IASB would have to reintroduce the concept of impairment for equity investments. Problems with recycling and impairment accounting under IAS 39 were the catalyst for the IASB’s overhauling accounting for financial instruments on an expedited basis.

Noting the ECOFIN’s concern that the IASB and FASB may arrive at different conclusions when financial instruments should be measured at fair value, the Chair said that both Boards have agreed on common principles to help achieve a common standard. That is the objective. At the same time, he emphasized that the IASB is conscious of the strongly held view of investors and other international stakeholders that a combination of cost-based and fair value accounting remains appropriate for financial instruments.