Comments from ACCA to the International Accounting Standards Board, July 2009. The ACCA is pleased to have this opportunity to comment on the exposure draft (ED) on the above subject, which has been considered by ACCA's Financial Reporting Committee.
Paragraph IN9 states the factors that were considered by the Board when considering the proposals in the ED. While we understand that there are some concerns about the derecognition of financial assets from preparers, users and regulators, we are not convinced that a fundamental change to the current requirements in IAS39 are needed. Indeed, we have concerns that some of the proposals in the ED may in fact result in more derecognition of financial assets than is the case with the risk and rewards tests currently required in IAS39. This would be contrary to the concerns raised during the current financial crisis in terms of transparency in accounting for transfer transactions. We believe that detailed field-testing of the proposals, and the impact they would have on financial statements, would be required to evidence the benefits of such significant amendments to the current requirements. This is especially so given that although there is an element of complexity in the current requirements, the risk and rewards model does appear to adequately account for transfer transactions.
We also note that the Board is in the process of revising IAS39. Again, although we understand that this is a difficult project and hence will be done in a number of steps, we are concerned that issues raised through one part of the consultation may have wider repercussions for the revised standard and the accounting for financial instruments as a whole.
QUESTION 1: Assessment of ‘the Asset' and ‘continuing involvement' at reporting entity level
Do you agree that the determination of the item (ie the Asset) to be evaluated for derecognition and the assessment of continuing involvement should be made at the level of the reporting entity (see paragraphs 15A, AG37A and AG47A)?
If not, why?
What would you propose instead, and why?
We agree that derecognition should be determined and continuing involvement should be assessed at the level of the reporting entity.
QUESTION 2: Determination of ‘the Asset' to be assessed for derecognition
Do you agree with the criteria proposed in paragraph 16A for what qualifies as the item (ie the Asset) to be assessed for derecognition?
If not, why?
What criteria would you propose instead, and why?
(Note: The criteria proposed in paragraph 16A are the same as those in IAS 39.) However, the Application guidance offers further clarification, see paras AG39A to AG43A.
The approach taken in the ED, is in line with that already being applied in IAS39. We strongly believe that unless there are significant issues with current accounting or apparent inconsistencies with other IFRS, the Board should refrain from making changes to existing requirements. We are not aware of any urgent concerns with determining a qualifying item for derecognition, and therefore support the approach taken in the ED.
QUESTION 3: Definition of ‘transfer'
Do you agree with the definition of a transfer proposed in paragraph 9?
If not, why?
How would you propose to amend the definition instead, and why?
We note that definition in paragraph 9 of the ED is broader than that currently outlined in IAS39 ( Paragraphs 18 & 19 ), suggesting that a greater emphasis on substance rather than form would be used when assessing when a transfer has occurred under the ED. While we would generally support definitions that focus on the economic substance of transactions, we are concerned that broadening the definition of a transfer could result in more transactions being derecognised than under the existing requirements.
The broadening of the definition may also result in inconsistent application and therefore add further complexity to the accounting derecognition.
We further note that one of the major concerns raised by the Financial Stability Forum in the context of the financial crisis related to transparency of off balance sheet activities and risks. While the ED notes that ‘a transfer does not necessarily result in derecognition', we believe that there is a risk that more transactions could be treated as transfers than is currently the case. And therefore the current proposals may not be an improvement to existing IFRS in this area.
QUESTION 4: Determination of ‘continuing involvement'
Do you agree with the ‘continuing involvement' filter proposed in paragraph 17A(b), and also the exceptions made to ‘continuing involvement' in paragraph 18A?
If not, why? What would you propose instead, and why?
Under existing requirements, an entity would consider the transfer or retention of risks and rewards, and if not, then assess the retention of control. However under the proposals in the ED, the risk and rewards test would be replaced with a test to assess whether the entity had continuing involvement.
While the objective of the continued involvement test is quite similar to that of the risk and rewards test in IAS39, we are particularly concerned about the move away from assessing ‘substantially all' risks and rewards to ‘no' continuing involvement for derecognition to occur.
While under the risk and rewards test, if these are ‘substantially' retained, there is no change in substance, and the transferor will continue to account for them in the essentially the same way, as it still has control . Under the proposals, the assumption that control has passed would not necessarily be the case.
As acknowledged in paragraphs BC59-61, there is likely to be a significant impact on current accounting, especially in relation to ‘repos' and similar contracts which are readily traded in the market. Under the proposals, such transactions would be accounted for as sales plus a derivative (ie the assets derecognised), rather than as secured loans. Our major concern here is that under the existing model, the transferring entity would be deemed to have retained substantially all the risks and rewards of ownership, and therefore continue to recognise the assets, while under the proposed model, the entity would treat the transfer as a sale and could lead to greater derecognition.
We believe that under the existing guidance, the risk and rewards tests have worked well, even in the financial crisis, and helped to ensure that items have not been taken off balance sheet. We therefore believe that the risk and rewards test should not be relinquished, and that additional field-testing should be carried out to ensure that a continued involvement model would not result in undue derecognition of financial assets which would otherwise have been recognised under the current model.
QUESTION 5: ‘Practical ability to transfer for own benefit' test
Do you agree with the proposed ‘practical ability to transfer' derecognition test in paragraph 17A(c)?
If not, why?
What would you propose instead, and why?
(Note: Other than the ‘for the transferee's own benefit' supplement, the ‘practical ability to transfer' test proposed in paragraph 17A(c) is the same as the control test in IAS 39.)
Do you agree with the ‘for the transferee's own benefit' test proposed as part of the ‘practical ability to transfer' test in paragraph 17A(c)? If not, why? What would you propose instead, and why?
Essentially this test is similar to that already in IAS39, although it appears to be given significant importance under the proposals. The basis for the test is that if the transferor has given up control of an asset, then the transferee does have control, and is free to do what it likes with it (ie ability to transfer, itself).
We do not believe it is appropriate to necessarily conclude that because the transferee might not have a practical ability to transfer the asset that the transferor should account for that asset. This is especially the case for pass-through arrangements where the majority of the risks and rewards have been transferred to the transferee but the transferor has some degree of continuing involvement (to the extent that it has still some of the risks and rewards) but not the majority.
QUESTION 6: Accounting for retained interests
Do you agree with the proposed accounting (both recognition and measurement) for an interest retained in a financial asset or a group of financial assets in a transfer that qualifies for derecognition (for a retained interest in a financial asset or group of financial assets, see paragraph 21A; for an interest in a financial asset or group of financial assets retained indirectly through an entity, see paragraph 22A)?
If not, why?
What would you propose instead, and why?
(Note: The accounting for a retained interest in a financial asset or group of financial assets that is proposed in paragraph 21A is not a change from IAS 39. However, the guidance for an interest in a financial asset or group of financial assets retained indirectly through an entity as proposed in paragraph 22A is new.)
We agree with the proposed accounting, which accounts for an interest retained in a financial asset (both directly and indirectly) as part of the initial asset.
QUESTION 7: Approach to derecognition of financial assets
Having gone through the steps/tests of the proposed approach to derecognition of financial assets (Questions 1–6), do you agree that the proposed approach as a whole should be established as the new approach for determining the derecognition of financial assets?
If not, why?
Do you believe that the alternative approach set out in the alternative views should be established as the new derecognition approach instead, and, if so, why?
If not, why?
What alternative approach would you propose instead, and why?
As we have previously stressed, for any changes to existing requirements to be considered, their cost / benefit should be adequately demonstrated through detailed field-testing of proposals. When looking at the area of derecognition, we believe this is even more important, given the fact that the changes often appear to be quite subtle, but could have a significant impact on certain types of transactions and certain industries in particular.
In terms of the proposals in the ED, there are some welcome clarifications and simplifications such as those on the level for the assessment of derecognition and the accounting for retained interests. However, we are not convinced that the proposals in the ED as a whole would offer a significant improvement to the current accounting. We are particularly concerned about transactions which under the proposals in the ED, would result in derecognition, despite the majority of risks and rewards still being retained by the transferring entity.
Indeed, while there are issues in terms of the complexity in applying some of the requirements in IAS39 relating to derecognition, we are not aware of any major situations where those requirements, based on an assessment of risk and rewards, have provided materially misleading information.
Unlike the alternative views, we do not believe that the current requirements in IAS39 which combine a risk and rewards approach with an assessment of control, do necessarily lead to inconsistent application in practice. As we have mentioned in our previous comment letters to the Boards recent consultative documents on business combinations (ED10) and revenue recognition, we believe that a control based approach, can and should be supplemented by a risk and rewards tests. This would ensure that assets and liabilities are kept on balance sheet where the entity is exposed to variability of the future cash flows (i.e. risks and rewards) or which are substantially controlled by the entity.
In order to fully conclude on the practicability of the alternative model, we would need a more detailed analysis than that provided in the ED. From the analysis included in the ED it appears that the alternative approach would result in more derecognition than at present which is not a helpful route to providing the greater transparency about these activities that users are demanding.
We would therefore like to the see the current requirements in IAS39 kept, although some of the proposals in the ED could be used to supplement those requirements where they offer clarification.
QUESTION 8: Interaction between consolidation and derecognition
In December 2008, the Board issued an exposure draft ED 10 Consolidated Financial Statements. As noted in paragraphs BC28 and BC29, the Board believes that its proposed approach to derecognition of financial assets in this exposure draft is similar to the approach proposed in ED 10 (albeit derecognition is applied at the level of assets and liabilities, whereas consolidation is assessed at the entity level).
Do you agree that the proposed derecognition and consolidation approaches are compatible?
If not, why?
Should the Board consider any other aspects of the proposed approaches to derecognition and consolidation before it finalises the exposure drafts?
If so, which ones, and why?
If the Board were to consider adopting the alternative approach, do you believe that that approach would be compatible with the proposed consolidation approach?
A principled approach should result in approaches for derecognition and consolidation being compatible. We are therefore concerned that there appear to be inconsistencies between the definition of control proposed in ED10 on consolidated financial statements, as based on power and returns with that of the definition of control in the ED as based on the ability to sell.
We believe that the compatibility of the two approaches can only be appropriately assessed through field-testing, and whether the resulting information from applying both approaches provides useful information. The field-testing could perhaps focus on transactions involving structured entities where both approaches are most likely to be applicable.
QUESTION 9: Derecognition of financial liabilities
Do you agree with the proposed amendments to the principle for derecognition of financial liabilities in paragraph 39A?
If not, why?
How would you propose to amend that principle instead, and why?
We do not have any issues with the proposals regarding derecognition of financial liabilities. This would be a change in the standard which would constituents would have to consider, but we are not sure that there is a significant problem in this regard in IAS39, nor does it seem likely to have a significant impact on current accounting. We query therefore whether this is a change worth making.
QUESTION 10: Transition
Do you agree with the proposed amendments to the transition guidance in paragraphs 106 and 107?
If not, why?
How would you propose to amend that guidance instead, and why?
We agree that any amendments made should be applied prospectively.
QUESTION 11: Disclosures
Do you agree with the proposed amendments to IFRS 7?
If not, why?
How would you propose to amend those requirements instead, and why?
Clearly and rightfully, the focus of the disclosure amendments is where Derecognition has occurred, and especially where the transferor retains an element of continued involvement.
The proposed disclosure requirements are more consistent with the fulsome disclosure requirements in US GAAP. However, we have concerns that they appear to be excessive and have been incorporated to appease concerns about assets and liabilities being derecognised, despite substantial risks and rewards being retained by the transferor.
While we can understand the logic to this, we would much prefer the criteria for derecognition itself to be more stringent, not dissimilar to existing requirements, and therefore keeping such assets and liabilities on balance sheet. This would mean less disclosure was needed in any case, and more importantly provide a more transparent reflection of the assets and liabilities involved – factors which have been high on the agenda of the Financial Stability Forum, and which should be the main concern of any standard dealing with derecognition of financial instruments.