International Briefing

Auditing Fair Value Measurements and Disclosures
Financial Reporting

Compiled by David Cairns, a consultant on international financial reporting issues and author of Applying International Accounting Standards (Tolleys, October 2002) and the International Accounting Standards Survey 2000 (

IASB: First-time application of IFRS

The International Accounting Standards Board has published ED 1, First-time Application of International Financial Reporting Standards, which deals with how an entity should make the transition to IFRSs from another basis of accounting such as national GAAP (see also this issue,

p 78). The proposals seek to ensure that all entities adopting IFRSs for the first time present comparative information in their financial statements that is as close as possible to the information provided by existing users of IFRSs but within cost/benefit constraints.

The proposals require, with limited exceptions, the full retrospective application of all IFRSs effective at the reporting date of an entity's first IFRS financial statements. There are specific exemptions dealing with instances in which retrospective application is likely to cause undue cost or effort.

The exemptions fall into three categories:

  • the use of some alternative measurement basis as deemed cost when the determination of cost may involve undue effort or cost;
  • the retention of some revaluations, price level adjustments and event-driven measurements even when cost can be determined without undue effort or cost; and
  • a prohibition of full retrospective application of IAS 39, Financial Instruments: Recognition and Measurement.

In addition, the IASB proposes to prohibit the retrospective application of IAS 22, Business Combinations. Among other things, this means that the carrying amounts of assets and liabilities immediately prior to the transition are deemed costs for IFRS purposes. Goodwill is not restated other than for previously recognised intangible assets that do not meet the recognition criteria in

IAS 38, Intangible Assets.

The proposals require an entity to comply with every IFRS current in the first year when it first adopts IFRSs. There is no need to go back to earlier versions.

IASB chairman Sir David Tweedie said: 'These proposals are very timely, considering the growing demand for high quality international standards. The impact will be felt far beyond the EU as the list of countries requiring companies to report using international standards grows.'

Copies of ED 1 are available from Comments are requested by 31 October 2002.

IFAC: Fair value measurements

The International Federation of Accountants' International Auditing and Assurance Standards Board (IAASB) has issued an International Standard on Auditing, , which addresses audit considerations relating to the valuation, measurement, presentation and disclosure for material assets, liabilities and specific components of equity presented or disclosed at fair value in financial statements including: understanding the entity's process for determining fair value measurements and disclosures and relevant control procedures; assessing the appropriateness of fair value measurements and disclosures; using the work of an expert; testing the entity's fair value measurements and disclosures; evaluating the results of audit procedures; management's process for determining fair value and management representations; and communication with those charged with governance.

The appendix to the ISA discusses fair value measurements and disclosures under different financial reporting frameworks.

Visit for copies of the ISA.

Canada: Enron issues addressed

The Accounting Standards Board (AcSB) has issued two draft accounting guidelines as part of its programme of improving Canadian GAAP in response to the failure of Enron.

Consolidation of Special Purpose Entities provides guidance on applying the consolidation principles in CICA 1590, Subsidiaries, to certain SPEs. Some SPEs rely on the financial support of another entity that is the primary beneficiary of the SPE's activities. The relationship between the SPE and the primary beneficiary is such that control over the SPE rests with the primary beneficiary, rather than with the nominal owner of the SPE. In such circumstances, the primary beneficiary should consolidate the SPE.

requires entities to disclose key information about certain types of guarantee contract that require payments contingent on specified types of future events. Disclosures would include the nature of the guarantee, how it arose, the events or circumstances that would trigger performance under the guarantee, the maximum potential future payments under the guarantee, the carrying amount of the related liability and information about recourse or collateral.

Copies of the draft guidelines are available from

IASB Meeting

Compiled by Lesley Bolton based on information supplied by the IASB (

The International Accounting Standards Board met in technical session in London on 16-19 July.

Business combinations - Phase 1

The IASB reconsidered the issue of the treatment of liabilities that arise as a consequence of a business combination. It concluded that a payment an entity is contractually required to make in the event that it is acquired in a business combination is an unrecognised contingent liability of that entity until it becomes probable that a business combination will occur.


IAS 37, Provisions, Contingent Liabilities and Contingent Assets, that obligation should be recognised as a liability by the entity when a business combination becomes probable and the liability can be reliably measured. Thus when the combination occurs, the liability will be recognised by the acquirer as a liability assumed as part of allocating the cost of the combination. The board agreed to amend the draft IFRS accordingly. Business combinations - Phase 2

Recognition and measurement issues related to acquired assets and assumed liabilities. The IASB considered, and will do so at future meetings, a number of circumstances in which additional implementation guidance might be necessary to ensure consistent application of the fair value hierarchy, which was agreed at June's meeting. Some of these circumstances relate to exceptions to fair value measurement. Others relate to changes from current practices that require additional clarification to ensure consistency with the working principle.

Scope. An earlier decision to exclude from this project issues related to the initial recognition and measurement of the acquiree's income tax assets and liabilities and assets and liabilities arising from post-employment benefits was noted. While recorded as part of the business combination, those items are not subsumed in the working principle and would not be measured at fair value. The recognition and measurement principles in

IAS 12, Income Taxes, would continue to apply to those income tax assets and liabilities. The recognition and measurement principles in IAS 19, Employee Benefits, would continue to apply to assets and liabilities arising from post-employment benefits.

Measurement when the occurrence of a business combination affects the acquired item's fair value. The IASB discussed the role of credit rating in measuring the fair value of liabilities assumed in a business combination and, in particular, it considered whether on initial recognition the fair value of an assumed liability should reflect (a) the credit rating applicable to an acquirer's liability before the combination; or (b) the credit rating applicable to a liability at the date of acquisition in the combined entity's financial statements.

It was tentatively agreed that application guidance should be provided in the IFRS, explaining that the fair value of a liability assumed by the acquirer in a business combination should be based on prices observed in recent market transactions for similar liabilities with a credit rating similar to that applicable to the liability assumed at the date of acquisition. If market prices are not observable, the fair value of liabilities assumed should be estimated using valuation techniques. These should incorporate the appropriate discount rate relevant to the credit rating applicable to the liability at the date of acquisition. That credit rating will reflect any effect of the business combination such as the assumption of the liability by the acquirer or the provision of an explicit or implicit guarantee.

Measurement of post-employment benefit obligations. The IASB discussed some limited issues relating to the initial measurement of the acquiree's post-employment benefit obligations under

IAS 19, including whether, and in what circumstances, the business combination itself affects the measurement of the post-employment benefit obligations.

The following circumstances were considered:

  • The acquirer has a different assessment of future events from the acquiree's and therefore uses different actuarial assumptions in estimating the acquiree's post-employment benefit obligation.
  • The terms of the post-employment benefit plan to be provided by the acquirer will differ from the terms of the acquiree's benefit plan because it is expected that the acquirer will (a) change the acquiree's plan to provide benefits to the acquiree's employees that are compatible with the benefits provided to its own employees; (b) curtail or terminate the acquiree's plan; or (c) otherwise restructure the acquiree's plan.
  • The acquirer will amend the post-employment benefit plan as a condition of the business combination agreement with the acquiree's owners.

It was tentatively agreed that the measurement of a post-employment benefit obligation assumed should be based on the acquirer's actuarial assumptions at the date of acquisition. The board indicated that it is necessary to distinguish clearly and accurately in the draft IFRS such changes to the actuarial assumptions from changes to the plan's actual terms.

It was agreed that any changes the acquirer contemplates to the plan's terms should not affect the measurement of the post-employment benefit obligation at the date of acquisition.-Instead, any effect of the changes should be considered as post-combination expenses of the combined entity. Changes to the terms of the acquiree's post-employment benefit plan should be reflected in the measurement of the post-employment benefit obligation at the date of acquisition only if those changes are made before the acquisition date.

Further, it was concluded that when amendments to the acquiree's post-employment benefit plan (usually improvements) are a condition of the business combination, the liability associated with those amendments that is attributable to services rendered by the plan's participants before the acquisition date:

  • is not a liability or contingent liability of the acquiree at the acquisition date;
  • should not be regarded as a liability assumed in exchange for assets given, liabilities incurred, and equity instruments issued by the acquirer.

The board concluded that obligations that are triggered by the business combination itself represent post-combination expenses of the combined entity.

Constructive obligations. The IASB considered the treatment of constructive obligations that arise as a result of the business combination that were not the acquiree's liabilities before the business combination (for example, the cost associated with restoring contaminated land of the acquiree that was not a constructive obligation of the acquiree but which, because of an established pattern of past practice, would be a constructive obligation of the acquirer). It was concluded that a constructive obligation that arises as a result of the business combination:

  • is not a liability or contingent liability of the acquiree at the acquisition date
  • should not be regarded as a liability assumed in exchange for assets given, liabilities incurred, and equity instruments issued by the acquirer.

The board concluded that a constructive obligation that is an acquiree's existing liability, but which would not be a constructive obligation of the acquirer after the business combination, should be recognised as part of recognising the assets acquired and liabilities assumed in the combination. However, that liability's fair value at the acquisition date would be close to zero.

Recognition criteria for assets acquired and liabilities assumed. The IASB concluded that the probability recognition criterion need not be included in the draft IFRS for assets acquired and liabilities assumed, because the acquirer is required to recognise those items at their fair values at the acquisition date. The fair value reflects market expectations about the probability that future economic benefits associated with the assets acquired and liabilities assumed will flow to or from the acquirer. In other words, the effect of probability is reflected in the fair value measurements of the assets acquired and liabilities assumed. However, the board agreed that the reliable measurement criterion should be retained.

The board also considered application guidance for determining whether an asset acquired or liability assumed in a business combination can be reliably measured.

Consolidation and SPEs

The IASB discussed consolidation policy, and its application to special purpose entities. The tentative decisions included, amongst other things:

General principles

  • Consolidation policy should be driven by the principle of reporting on economic entities.
  • The borders of economic reporting entities should be determined by the same control notion that underpins the definitions of the assets.
  • In deciding which entities should be part of reporting entities, ie, be consolidated, control should be defined in terms of the capacity to control in order to benefit. Exercise of that capacity is not required. The definition of control for the purposes of consolidation may be different from that for individual assets.
  • Consolidated financial reports should reflect the entities that are controlled at the balance sheet date. For example, the board agreed that control could exist where a shareholding of less than 50% is held and the remaining shares are widely dispersed among passive holders. Nonconsolidation should not be allowed simply because dispersed shareholders could coalesce in the future.
  • Options to buy shares are one of the factors to be considered in determining whether there is control of an entity.
  • Minority interests are equity contributors to the economic entity. This does not negate the case for separate disclosures of their interests.
  • When an entity is acquired and there is an intention or obligation to resell the interests in that entity, consolidation of the assets of the acquired entity may not be appropriate.
  • Only one entity can control another entity.
  • Restrictions on the control of assets can raise questions of non-recognition/derecognition or impairment.

Special purpose entities

  • The board wishes to prepare a comprehensive standard covering consolidation of both non-SPEs and SPEs.
  • Consistent criteria should be developed for all entities, whether or not SPEs and whether passive, rather than excluding certain categories of entities from application of the provisions.
  • The board agreed generally with the circumstances identified in the US Financial Accounting Standards Board's proposed interpretation in which traditional means of identifying the existence of control may not assist.
  • In order to determine which entity should consolidate, consideration must be given to the order of loss, the size of the potential loss exposure and the benefits applicable to each party's interests.
  • Application of the principles may result in no entity consolidating an SPE.

The IASB continued its consideration of IASs with requirements under national generally accepted accounting principles with a view to identifying where convergence could be achieved in a relatively short time. It was agreed that the national standard-setters should be asked to consider the comparisons and identify areas where they also could start their own convergence work.

The board agreed that it would discuss with the US FASB those areas that could be tackled as joint projects. The board would then be able to discuss with other national standard-setters what progress towards convergence could be achieved by the end of 2004.

Deposit-taking, lending and securities activities

The IASB discussed the proposals for disclosure and presentation of financial assets, financial liabilities, income and expenses resulting from deposit-taking, lending and securities activities, as well as disclosure relating to financial risks associated with such activities.

It expressed concern over the volume of disclosures that could result in some circumstances. It discussed some of the similarities in the areas of risks to be disclosed with the existing requirements of

IAS 32, Financial Instruments: Disclosure and Presentation. The board agreed to ask the project's advisory group to consider the interaction between the proposed financial risk disclosures and the requirements of IAS 32, and whether a common set of principles for disclosure could be developed for all entities to apply. Under this approach, some of the disclosure requirements in IAS 32 might need revision or clarification, and some of the more detailed disclosures proposed in the project might form application guidance.

The board discussed the line items proposed on the face of the balance sheet and the face of the income statement, and, given that the scope of the project was wider than the scope of

IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, the interaction with the requirements of IAS 1, Presentation of Financial Statements, IAS 32 and IAS 39, Financial Instruments: Recognition and Measurement. Some members were uncertain why certain line items were proposed, when existing standards already required disclosure of similar amounts in the notes to the financial statements. The board asked the advisory group to reconsider what, if any, line items should be presented on the face of the balance sheet and the income statement. Reporting performance

The IASB continued its discussion of cash flow hedges, focusing on the problems caused when income or expenses on hedging instruments arise in periods different from those on hedged items.

The board agreed that only the 'no recycling' approach, whereby all income and expenses are recognised once only and cash flow hedge accounting is in effect prohibited, was consistent both with the and a single statement of comprehensive income. It also agreed, however, that this issue was part of a much larger project eventually to reconsider accounting for financial instruments. It was beyond the scope of the reporting performance project.

The board also tentatively agreed that there should be a separate cash flow hedging category within both the operating and financing sections in the performance statement and that there should be no distinction within the statement of changes in equity or the balance sheet between retained earnings and any notional cash flow hedge reserve. In addition, ' quasirecycling' - whereby income and expenses on hedging instruments are reported in a separate 'cash flow hedging' category, and subsequently 'recycled' within the statement of comprehensive income into the same functional line item as the hedged item - should be allowed for the special case of cash flow hedges only and no other recycling in the performance statement would be permitted.

The IASB discussed other aspects of the project and tentatively concluded that the staff should prepare a summary paper on the project. Following discussions between the board, the national standard-setters and the Standards Advisory Council, field visits to users and preparers would take place. In addition, the project should move directly to an exposure draft, without first issuing a discussion paper, with a target date for the release of the first quarter 2003.

Share-based payment

The IASB discussed the accounting treatment of employee share options, with the aim of reaching some overall conclusions. It tentatively concluded:

  • The IFRS should require a fair value measurement method to be applied to all types of share-based payment transactions, including all types of employee share-based payment.
  • Therefore, the IFRS should not follow the same approach as US accounting requirements. In other words, entities should not be permitted a choice between recognition and disclosure of expenses arising from employee share-based payment transactions.

The board then discussed some detailed accounting and measurement issues. It also discussed the possibility that some options might have very complex features, which make it difficult-to estimate their fair value. The board tentatively agreed that there should be no exceptions to the requirement to apply a fair value measurement method. Therefore, failing to comply with the requirement would represent a departure from the IFRS. The board tentatively agreed that, in this situation, the entity should disclose why it has been unable to estimate the fair value of options.

The board discussed the definition of grant date. It tentatively agreed that grant date should be defined as the date when an agreement has been reached between the entity and its employees (or other parties) to receive shares, options or other equity instruments issued by the entity, provided the specified vesting conditions, if any, are met. The board also tentatively agreed that if the share/option plan is subject to an approval process (for example, shareholder approval), grant date is the date when that approval is obtained.

For share-based payment transactions measured at the fair value of the goods or services received, the board tentatively agreed that fair value should be estimated at the date of receipt of those goods or services.

The board also tentatively agreed that the IFRS should contain application guidance on the valuation implications of dividends paid during the period between grant date and exercise date.

The board discussed the accounting treatment of share/option plans that are cancelled during the vesting period (other than individual cancellations caused by the departure of employees). The board tentatively agreed that the entity should continue to account for services received during the vesting period, using the grant date, fair value measurement method.

The IASB also discussed consequential amendments to other standards, and tentatively agreed that when the IFRS becomes effective:

  • the section on equity compensation benefits in IAS 19 should be deleted;
  • the scope exclusions in IAS 32 and IAS 39 should be modified to exclude rights and obligations arising from transactions falling within the scope of the IFRS on share-based payment.

The board continued its discussion of an issue relating to share plans with cash alternatives, previously discussed at its June meeting. It tentatively concluded that for such share plans where the entity has the choice of settlement and where no liability arises, the transaction should be measured based on the grant date fair value of the equity instruments' alternative and recognised over the vesting period, in the same manner as other forms of equity-settled sharebased payment transactions.

The board also discussed the tax effects of share-based payment transactions. It tentatively agreed that all tax effects should be included in the income statement.

The staff were asked to begin drafting an exposure draft, based on the tentative conclusion to date.

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