On May, 28th, 2015 the IASB published the ED/2015/3 in which the IASB presents its proposals for the whole updated Conceptual Framework. Apart from the waiver of the separate recognition criteria for assets and liabilities and the general rules for the derecognition of assets and liabilities the most remarkable proposals are the factors to consider when selecting a measurement basis and the refutable presumptions for the delineation of the other comprehensive income. This article analyses the potential impacts of these proposals on the measurement of some asset items and the recognition of the therewith linked income and expenses. The analysis shows that probably only a part of assets that are according to existing IAS/IFRS measured at a current measurement basis fulfill the criteria according to the ED/2015/3. In addition, according to the proposals of the ED/2015/3 the fair value changes or the revaluation effects of most of the analysed assets which also qualify for the use of a current measurement basis according to ED/2015/3 should be recognised in the other comprehensive income that will be reclassified subsequently to profit or loss when specific conditions are met. Therefore, it could be supposed that the future Conceptual Framework will have quite a lot more effects than the IASB outlines in its Basis of Conclusions (ED/2015/3 BCE).

I INTRODUCTION

On May, 28th, 2015 the IASB published its “Exposure Draft: Conceptual Framework for Financial Reporting” (in the following ED/2015/3). Therewith, the IASB intends primarily to update the current Conceptual Framework and to fill in gaps instead of reconsidering all aspects of the Conceptual Framework.

Although the IASB proposes in nearly all fields of the future Conceptual Framework (CF) remarkable proposals, e.g. the waiver of the separate recognition criteria in the existing CF, or for the first time conceptual rules for the derecognition of assets and liabilities and the therewith combined relevance of the unit of account, most important are the suggestions regarding the measurement and the delineation of the other comprehensive income. In the opposite of the existing CF, ED/2015/3 proposes factors that should be taken into account when selecting a measurement basis. Although during the last two decades the number of income and expense items that are recognised in the other comprehensive income has been increased significantly, general criteria are still missing that allow a clear separation of items which have to be recognised in the other comprehensive income. This is quite a serious deficit of an accounting system that claims to be principle-based.1

ED/2015/3 confirms the objective and the qualitative characteristics of the joint Conceptual Framework project undertaken before jointly with the FASB. Nevertheless, the fundamental qualitative characteristic “relevance” is supplemented by an explicit reference to the aspect of “measurement uncertainty”. The IASB states that the level of measurement uncertainty is one factor that affects the relevance of financial information.2 Measurement uncertainty arises when a measure for an asset or a liability cannot be observed directly and must instead be estimated.3 The IASB acknowledges a trade-off between the level of measurement uncertainty and other factors that make information relevant.4 Although a low level of measurement uncertainty is in general desirable, even a high level of measurement uncertainty linked with an estimate does not prevent the use of this estimate if it provides the most relevant information.5

Further remarkable is the reference of the “neutrality” (component of the faithful representation) to a re-introduced principle of prudence that is defined as the exercise of caution when making judgements under condition of uncertainty.6 This kind of prudence (“cautious prudence”) allows neither the overstatement of assets and income (resp. the understatement of liabilities and expenses) nor the understatement of assets and income (resp. the overstatement of liabilities and expenses). The IASB argues that also the understatement of assets and income (resp. the overstatement of liabilities and expenses) is incompatible with the exercise of prudence because such misstatements will lead in future periods to an overstatement of income or an understatement of expenses.7

The proposed main changes in chapter 4 and 5 affect the definitions of the elements in the statement of financial position and the therewith linked waiver of additional recognition criteria of assets and liabilities8 and the rules for the derecognition of assets and liabilities which fill a gap in the existing CF. A significant difference of the proposed definitions of the elements of the statement of financial position according to ED/2015/3 is that the economic resource (resp. the present obligation) is the asset (resp. the liability) and not an expected inflow (resp. outflow) of future expected benefits from the asset (resp. liability).9 An asset must already exist and there is at least one circumstance in which the economic resource would produce economic benefits. The inflows of the future expected benefits need not to be certain or even probable.10 Examples for assets are purchased options that create value only when the conditions are met under which they could be exercised11 or even lottery tickets, because the resource is the right to participate in the lottery, not the cash prizes.12 Therefore, ED/2015/3 proposes to renounce the recognition criteria that are used in the existing CF (i.e. probability of an inflow or outflow of future economic benefits linked with an asset resp. liability and the existence of a reliable measurement of this asset resp. liability). Due to this, the number of assets and liabilities which qualify for recognition in the statement of financial position will probably increase. Especially self-generated intangibles13 and also provisions14 may be affected by these proposals of the ED/2015/3.15 Despite this, on the level of the specific standards other factors may also influence the recognition of assets and liabilities, like the relevance of information, the faithful representation or limitations arising from cost constraints.16

As already stated above, the focus of the following sections of this article is on the proposals regarding the measurement and the partly therewith linked delineation of the other comprehensive income. In the next step, the article analyses the potential impacts of these proposals on the measurement of some selected items of the statement of financial position and the recognition of the therewith linked income and expenses. Nevertheless, it has to be outlined, that also the future CF will not override any rule in a specific standard.17 In order to change an IAS/IFRS an own due process must have to be taken place. Furthermore, in the case of a departure from an aspect of the future CF, ED/2015/3. IN 3 requires that in the Basis of Conclusions accompanying the IAS/IFRS with the departing rule the departure has to be explained.

SeeBallwieser, Wolfgang: IFRS-Rechnungslegung, 3. edition, München 2013, pp. 23.

See ED/2015/3. chapter 2.12 sent. 1.

See ED/2015/3. chapter 2.12 sent. 2.

See ED/2015/3. chapter 2.13 sent. 3.

See ED/2015/3. chapter 2.13 sent. 5.

See ED/2015/3. chapter 2.18 sent. 2.

See ED/2015/3. chapter 2.18 sent. 4.

See CF. 4.44 and 4.46.

See for comparison the existing definitions in CF. 4.4 a) and b).

See ED/2015/3. chapter 4.13. The same goes for the definition of the liabilities (see ED/2015/3. chapter 4.27).

See ED/2015/3. chapter 4.15.

See DP/2013/1. chapter 2.14 e).

Compare in this context the different recognition criteria for acquired intangibles (see IAS 38.9–38.17) and self-generated intangibles (see IAS 38.57).

See IAS 37.14, especially the required probable outflow of resources embodying economic benefits as one criterion for recognising provisions in the statement of financial position (see IAS 37.14 b).

See ED/2015/3. BCE 12 f. for the inconsistency already acknowledged by the IASB.

The IASB discusses in a more general way the aspects that could limit the recognition of all assets and liabilities in the statement of financial position (ED/2015/3. chapter 5.13–5.24).

Vgl. ED/2015/3. IN 2.

1 Measurement of assets and liabilities

Due to the analysis of the fundamental and some enhancing qualitative characteristics the IASB derives that the use of a single measurement basis would not provide relevant information and is therefore not desirable.18 The IASB identifies two measurement bases19 which should be used for the measurement of assets and liabilities:

  • historical cost: In addition, also measures that are derived from the historical cost, like cost less accumulated depreciations and amortizations, belong to this category.

  • current value: Measures based on current value provide monetary information about assets, liabilities using information that is updated to reflect conditions at the measurement date. Current value measurement bases include the fair value and the value in use for assets and the fulfillment value for liabilities as the entity-specific values.20 Measures that are based on cash flows are not an own category of measurement bases. Instead they are categorized as measurement techniques which support the determination of the value in use for assets and the fulfillment value for liabilities, especially provisions, or the determination of fair values if they cannot be observed directly.21

In order to provide useful financial information the IASB derives that initial and subsequent measurement could not be considered separately, and also the effects on the profit or loss statement (p/l-statement) have to be taken into account when selecting an appropriate measurement basis.22 Therefore the measurement bases used for the initial and subsequent measurement should be the same or consistent. Despite this, the IASB does neither prevent a change of the measurement basis if this change is necessary to provide useful financial information nor different measurement bases in the statement of financial position and the p/l-statement.23

Furthermore, the IASB discusses the factors to consider when selecting a measurement basis for assets and liabilities. In the opposite to DP/2013/1,24 the IASB avoids a direct mapping of the measurement bases to the different kinds of assets and liabilities because the CF should not anticipate decisions that have to be taken on the level of each standard.25 By selecting an appropriate measurement basis, the following factors have to be considered:

  • relevance of the financial information produced by the use of a measurement basis in both, the statement of financial position and the p/l-statement:26 Thereby the manner of contributing cash flows (e.g. producing cash flows by sale or use of an asset in the entity in dependence on the applied business model) and the characteristics of the assets resp. liabilities (e.g. nature or extent of variability in the item’s cash flows) have to be taken into account.27 A further aspect of the relevance is the measurement uncertainty linked to the use of a particular measurement basis.28

  • Faithful representation of financial information produced by the use of a particular measurement basis: Faithful representation does not mean accuracy in all respects but the character of estimations and their limitations have to be described properly.29 Furthermore, faithful representation aims at the avoidance of accounting mismatches, i.e. assets and liabilities which stand in a close relationship should be measured at the same or at least with similar measurement bases (e.g. claim for compensation for damages and the therewith linked and underlying provision).30

  • Furthermore comparability and understandability of financial information influence the selection of an appropriate measurement basis. In general, due to these enhancing qualitative characteristics the number of different measurement bases used in the financial statements should be reduced as far as possible.31

See ED/2015/3. BC 6.7–6.14, especially 6.9.

See ED/2015/3. chapter 6.4–6.47.

See ED/2015/3. chapter 6.19 and 6.34.

See ED/2015/3. Appendix A 1.

See ED/2015/3. chapter 6.52.

See ED/2015/3. chapter 6.74–6.77.

See Kirsch, Hans-Jürgen/Schoo, Lena/Kraft, Ariane, Das Discussion Paper zum Conceptual Framework des IASB, in: WPg, Die Wirtschaftsprüfung 2014, pp. 301–310, here pp. 306.

See ED/2015/3. BC 6.49.

See ED/2015/3. chapter 6.53.

See ED/2015/3. chapter 6.54.

See ED/2015/3. chapter 6.55–6.56 and section I.

See ED/2015/3. chapter 6.57.

See ED/2015/3. chapter 6.58.

See ED/2015/3. chapter 6.60 and 6.62.

2 Delineation of the other comprehensive income

In the opposite to the DP/2013/1,32 the IASB does not propose any conceptual approach for the delineation of the other comprehensive income. Instead of this, the IASB tries to differentiate the other comprehensive income from net income by a set of refutable presumptions. In the IASB’s view the p/l-statement is the primary source of information about an entity’s financial performance for the period. From this follows that there is a presumption that all income and all expenses will be included in the p/l-statement.33 According to ED/2015/3. chapter 7.24 this presumption can only be rebutted for:

  • income or expenses are related to assets and liabilities that are measured at current values34 (in the case of separately identified components of income and expenses only components of that type are qualifying for being recognised in the other comprehensive income that would not arise if the related assets and liabilities are measured at historical cost35), and

  • excluding those income or expenses (or components of them) from the p/l-statement would enhance the relevance of information in the p/l-statement.

In addition, according to ED/2015/3. chapter 7.26 sent. 1 if income and expenses are included in the other comprehensive income in one period, there is a (refutable) presumption that they will be reclassified into the p/l-statement in some future period. That reclassification takes place when it will enhance the relevance of financial information included in the p/l-statement for that future period.36 Despite this, the presumption that such a reclassification will occur could be rebutted if there is no clear basis for identifying the period in which reclassification would enhance the relevance of the information in the p/l-statement.37 If the rebuttal is successful and no basis for reclassification can be identified, this may indicate that the income or expense should not be included in the other comprehensive income.38

See Kirsch, Hans-Jürgen/Schoo, Lena/Kraft, Ariane (Fn. 24), here p. 308; Erb, Carsten/Pelger, Christoph, Potenzielle Praxisimplikationen des Diskussionspapiers zum zukünftigen IFRS-Rahmenkonzept, IRZ, Zeitschrift für internationale Rechnungslegung 2014, pp. 21–25, here pp. 24.

See ED/2015/3. chapter 7.23 sent. 1.

See section I.1.

See ED/2015/3. chapter 7.24 a) in combination with 7.23 b) and for an example of different measurement bases in the statement of financial position and the p/l-statement ED/2015/3. chapter 7.25.

Vgl. ED/2015/3. chapter 7.26 sent. 2.

See ED/2015/3. chapter 7.27 sent. 1.

See ED/2015/3. chapter 7.27 sent. 2.

II POTENTIAL IMPACTS OF THE PROPOSALS OF THE ED/2015/3 ON THE MEASUREMENT OF SELECTED ITEMS OF THE STATEMENT OF FINANCIAL POSITION AND THE RECOGNITION OF THE THEREWITH LINKED INCOME AND EXPENSES

1 Revaluation of tangible fixed assets and intangibles

a) Current situation

According to IAS 16.29 and IAS 38.72, IFRS applying entities have the accounting choice to measure tangible fixed assets and intangibles after initial recognition at cost less accumulated depreciations and accumulated impairment losses or at revalued amounts. By application of the revaluation model, in general39 gains and losses from the revaluation are recognised in the other comprehensive income that will not be reclassified subsequently to profit or loss;40 in the statement of financial position the accumulated gains from the revaluation of these assets are presented as revaluation reserve that forms part of the entity’s equity. If a non-depreciable asset (e.g. land) is sold the corresponding revaluation reserve may be transferred directly to the retained earnings and does not touch the p/l-statement any more.41 Regarding the depreciable assets, there is neither in IAS 16 nor in IAS 38 a statement what basis for calculating the depreciation charge should be used. Due to the predominating opinion in literature, revalued assets that are subject to wear and tear shall be depreciated from revalued amounts;42 the decrease of the revaluation surplus due to wear and tear of these assets is considered by a transfer from the revaluation surplus to the retained earnings proportionate to the use of these assets.43 Only some authors believe that for calculating depreciations on revalued assets also a cost basis could be used. In addition to the depreciation from cost basis in the p/l-statement, these authors propose to recognise an expense for the difference between the depreciation from revalued amounts and from cost basis in the other comprehensive income. This expense in the other comprehensive income for the time or use related reduction of the revaluation surplus is credited against the carrying amount of the revalued asset in order to avoid an overstatement of both, the assets and the equity.44

Despite this, impairment losses that reduce the carrying amount below the cost less accumulated depreciations and impairment gains which reverse a revaluation decrease of the same asset previously recognised in profit or loss are recognised in profit or loss (IAS 16.40 sent. 1 and IAS 16.39 sent. 2 resp. IAS 38.86 sent. 1 and IAS 38.85 sent. 2).

See IAS 16.39 sent. 1 and IAS 16.40 sent. 2 resp. IAS 38.85 sent. 1 and IAS 38.86 sent. 2 and IAS 1.96 sent. 2.

See IAS 1.96 sent. 3 and IAS 16.41 sent. 1 resp. IAS 38.87 sent. 1.

See for example Cairns/Creighton/Daniels, Applying IAS, 3. Aufl., London 2002, p. 513; Pellens, Bernhard/Fülbier, Rolf-Uwe/Gassen, Joachim/Sellhorn, Thorsten, Internationale Rechnungslegung nach IFRS, 9. edit., Stuttgart 2014, p. 367.

See IAS 16.41 sent. 3 f. and IAS 38.88 sent. 3 f. and for an example Heuser, Paul J./Theile, Carsten, IFRS-Handbuch, 5. edit., Köln 2012, Tz. 1300.

See Lüdenbach, Norbert/Hoffmann, Wolf-Dieter/Freiberg, Jens (edit.), Haufe IFRS-Kommentar, 13. edit, Freiburg et. al. 2015, § 8 Rz. 83; Tanski, Joachim, Sachanlagen nach IFRS, München 2005, p. 130.

b) Selection of an appropriate measurement basis according to ED/2015/3

First, it has to be analysed if the assets for which the accounting choice of IAS 16.29 and IAS 38.72 exists still qualify also for the use of a current value measurement basis according to the proposals contained in the ED/2015/3. ED/2015/3. chapter 6.54 mentions as factors which have to be considered when selecting an appropriate measurement basis the manner of contributing cash flows (e.g. producing cash flows in a direct way by selling the asset vs. producing cash flows by the use of the asset in the entity’s production process and the sale of the therefrom generated goods or services) and the characteristics of the assets (especially the causes for the variability in the item’s cash flows). As mentioned above45 the IASB avoids in ED/2015/3 a direct mapping of measurement bases to the different kinds of assets and liabilities. Despite the quite high and abstract level of discussion of factors that according to ED/2015/3. chapter 6.53–6.77 influence the selection of the appropriate measurement basis of assets and liabilities the IASB’s general view regarding the appropriate measurement bases seems to be quite very similar compared to the assessments of the preceding DP/2013/1. Therefore, the classifications proposed in DP/2013/1 could also be consulted in addition:

  • In the terminology of ED/2015/3, a historical cost basis should be applied, if assets only in combination with other assets produce cash flows and/or variations of cash flows are caused more by risks inherent to the assets than to changes in market factors.46 According to DP/2013/1. chapter 6.78–6.79 an asset that contributes indirectly to future cash flows in the course of the operating activities (assets used in purchasing, producing, marketing or delivering assets or services, or administration, treasury or any other function to keep the entity operating) has to be measured with a cost basis.

  • Assets that generate cash flows by leasing, renting, franchising, generating entry fees or similar have an ambivalent character in regard to the selection of an appropriate measurement basis. In the opposite to the assets that are measured with a current value measurement basis, the economic benefits embodied in these assets are not realized by one sales act. On the other side, in most cases these assets produce cash flows by their own and are not integrated in the entity’s operating activities. Furthermore, the cash flows of these assets do not only depend on the efficiency of the leased, rented or franchised asset but also the market valuations of these assets have a strong impact on the amount of the therewith produced cash flows. Due to this ambivalent character, DP/2013/1. chapter 6.94–6.95 states that either a cost-based measurement or current market prices can provide relevant information. In addition, the relevance of a current value measurement basis is supposed to increase by the value of the individual asset.47

Therefore, probably only a smaller part of the assets for which there is at present the accounting choice for revaluation would qualify for the use of a current value measurement basis according to ED/2015/3. Tangible fixed assets and intangibles which are used for the entity’s operating activities do not fulfill the criteria for selecting a current value measurement basis. In contrast, assets that are leased, rented, subject to franchising, or similar can qualify for the use of a current value measurement basis. If these long-lived assets are leased, rented or subject of franchising on a long-time basis the level of measurement uncertainty is quite low as the conditions of leasing, renting or franchising are regulated in the respective contracts; under these circumstances there are strong arguments in favour of the use of a current value measurement basis.48 This also applies for assets that are leased, rented or subject of franchising on a short term basis but which are traded on active markets (e.g. property).

Compare section I.1.

See ED/2015/3. chapter 6.54 a) and b).

See DP/2013/1. chapter 6.95.

See ED/2015/3. chapter 6.56.

c) Recognition of gains and losses from revaluation in the other comprehensive income according to ED/2015/3

Prerequisite for recognising the gains and losses from revaluation in the other comprehensive income are the two conditions mentioned in ED/2015/3. chapter 7.24. The use of a current value measurement basis is only possible for the identified part of long-lived assets.49 If these assets that are not integrated in the entity’s operating activities are hold for a longer period the inclusion of revaluation gains or losses in the other comprehensive income will regularly enhance the relevance of the financial information in the p/l-statement as these gains and losses can be reversed during the holding period of these assets. Therefore gains and losses from the revaluation of long-lived tangible fixed assets and intangibles that are not used for the entity’s operating activities fulfill also the criteria of ED/2015/3. chapter 7.24 for the recognition in the other comprehensive income.

Notwithstanding this, if gains or losses are recognised in the other comprehensive income ED/2015/3. chapter 7.27 presumes refutably that there exists a clear basis for identifying the period in which reclassification would enhance the relevance of the information in the p/l-statement. If a non-depreciable revalued asset is sold or is retired at that point in time the accumulated other comprehensive income could be reclassified into the p/l-statement. If this occurs the gains and losses from the sale or other retirement of long-lived revalued assets would be recognised in the p/l-statement in the same way as the gains and losses from sales of long-lived assets measured at a historical cost basis. This seems to be in favour of reclassifying the gains and losses from revaluation into the p/l-statement. Also the understandability and comparability will probably be enhanced by the reclassification if gains and losses from the sale or other retirement of all long-lived assets are recognised in the same way.

In the case of assets that are subject to wear and tear corresponding to the depreciation from the current value measurement basis a reclassification into the p/l-statement could take place in order to reflect the reduction of the revaluation surplus caused by use. In this case in the other comprehensive income for the reduction of the revaluation surplus an expense is recognised at an amount of the difference between the depreciation from current value measurement and cost basis; in the p/l-statement a corresponding income is recognised. This time or use related reclassification leads in the p/l-statement thereto that both, this reclassification adjustment and the depreciation of the revalued asset calculated from the current value measurement basis together are as high as the depreciation derived from cost basis. Therefore, the effects on both, the p/l-statement and the other comprehensive income, are in the case of reclassifying gains from prior revaluations to the p/l-statement the same as in the present revaluation model (without reclassification) if the revalued assets are depreciated from cost.50 If the revalued depreciable assets are sold or retired otherwise regarding the reclassification of the accumulated gains at the time of sale or other retirement the same goes analogous as for the above mentioned non-depreciable assets.

See section II. 1 b).

Compare section II. 1. a) for this opinion which is permissible according to the opinion of only a few authors.

2 Option of recognising the fair value adjustments of equity instruments not held for trading

a) Current situation

According to IFRS 9 the equity instruments have to be measured at fair value. At initial recognition, for the equity instruments are neither held for trading nor contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies the entity is entitled to make the irrevocable election to present in the other comprehensive income that will not be reclassified subsequently to profit or loss the changes in fair value of these equity instruments.51 This also applies in the cases of impairment, sale or other retirement of these investments. Nevertheless, also by exercising the irrevocable election of IFRS 9. chapter 5.7.5 dividends from these investments must be recognised in the p/l-statement.52

See IFRS 9. chapter 5.7.5 in combination with IFRS 9. Appendix B 5.7.1.

See IFRS 9. chapter 5.7.6. The only exception applies if the dividend clearly represents a recovery of part of the cost of the investment (IFRS 9. Appendix B 5.7.1 sent. 5).

b) Selection of an appropriate measurement basis according to ED/2015/3

The factors that have to be considered when selecting an appropriate measurement basis show in the case of the equity instruments not held for trading the following picture:

  • These equity instruments generate cash flows by receiving dividends and proceeds from sale when selling them. An integration of these investments in the entity’s operating activities does regularly not take place as investments in associates, joint ventures or subsidiaries are excluded from the scope of IFRS 9.53 Compared to the long-lived assets that are leased, rented, or subject of franchising which are mentioned under section II. 1 b), the degree of generating cash flows by the sale of the assets should be significantly higher as the investments in the equity instruments are non-depreciable assets.54 Therefore there is a much stronger argument in favour of the use of a current value measurement basis instead of only an accounting choice between a current value and a historical cost measurement basis.55

  • The variability in the equity instrument’s cash flows depends on both, the characteristics of the investments (especially the variability of dividends which reflect the performance and the strength of the financial position of the underlying investment) and on market factors (especially the sales price that is also influenced by interest rates, the volatility, the market participants’ expectations or the fungibility of the equity instruments). The variability in the equity instrument’s cash flows is more in favour of an accounting choice between a historical cost and a current value measurement basis.

  • The level of measurement uncertainty of the equity instruments that are traded on public markets, especially active markets, is regularly quite very low. In addition, also the faithful representation is in these cases in favour of the use of a current value measurement basis, especially the fair value.56

  • Even in the case of non-publicly traded equity instruments the IASB assumes that the valuation models for investments in equity instruments are in contrast to the valuation of options sufficiently developed.57 Therefore, the level of measurement uncertainty is also quite acceptable, especially if the necessary estimations are properly described and disclosed;58 the same also applies for the faithful representation.59

From all this follows, that the equity instruments not held for trading qualify also for the use of a current value measurement basis according to the proposals of ED/2015/3.

See for the scope of this standard IFRS 9. chapter 2.1 a).

In this context it has to be kept in mind that dividends which clearly represent a recovery of part of the cost of the investment are not recognised as income (IFRS 9. Appendix B 5.7.1 sent. 5).

Compare section II. 1. b).

See ED/2015/3. chapter 6.57.

See IFRS 9. BC 5.17 b).

See ED/2015/3. chapter 2.12 sent. 3.

See ED/2015/3. chapter 6.57 sent. 2.

c) Recognition of gains and losses from fair value adjustments in the other comprehensive income according to ED/2015/3

According to the proposals of ED/2015/3, a recognition of the change in the fair value of these equity instruments in the other comprehensive income is only possible if – unchanged to IFRS 9. chapter 5.7.6 – dividends are recognised in the p/l-statement because also in the case of the hypothetical use of a historical cost measurement basis dividends would be recognised in the p/l-statement.60 Furthermore, according to ED/2015/3. chapter 7.24 b) the relevance of the financial information in the p/l-statement must be enhanced by excluding these fair value changes from the p/l-statement. The last mentioned requirement for recognising these fair value adjustments outside the p/l-statement can be justified because recognising fair value changes on these investments not held for trading that arise during a particular reporting period in the p/l-statement might cause irrelevant fluctuations in the net income excepted for sustainable impairments of these investments.

The presumption of ED/2015/3. chapter 7.27 sent. 1 that there exists a clear basis for identifying the period in which reclassification would enhance the relevance of the information in the p/l-statement cannot be rebutted. A reclassification will enhance the relevance of information in the p/l-statement, if the final results of holding these equity instruments are certain (in the case of sale or other retirement) or virtually certain (e.g. in the case of sustainable asset impairments). Nevertheless, the peculiar character of these gains and losses (i.e. infrequent gain or loss that is attributable to the holding period of these equity instruments and not only to the current reporting period) possibly embodied in the p/l-statement should be presented or explained.61 Remarkable in this context is that the IASB does not justify the recognition of these fair value changes in the other comprehensive income that will not be reclassified subsequently to profit or loss with the usefulness or relevance of the information but only with a lower complexity of the accounting rules in comparison to IAS 39.62

Compare regarding this requirement ED/2015/3. chapter 7.24 a) in combination with 7.23 b).

The same applies to the gains and losses from financial assets that are not measured at fair value through profit or loss which are attributable not only to the current but also to previous reporting periods. See for separate presentations in the p/l-statement IAS 1.82 aa), ca) and cb).

See IFRS 9.BC 5.25 b).

3 Choice of accounting policy for investment property

a) Current situation

Investment properties are properties (land or buildings) held to earn rentals or capital appreciation or both.63 Investment properties produce cash flows in a direct way, independently of other assets, by selling the asset or on its own.64 That differ investment properties from owner-occupied property held for use in production of goods and services, use in supply of goods and services or administrative purposes. At initial recognition investment properties are measured at cost, transaction costs included.65 After initial recognition cost model or fair value model is selected.66 Gains and losses due to changes in fair value are recognised in the p/I-statement. If cost model is selected, information about the fair value must be reported.67 In Sweden all of the listed companies have chosen the fair value model. One reason, besides more relevant information, might be that fair values must be reported anyway.68

See IAS 40.5.

See IAS 40.7.

See IAS 40.20.

See IAS 40.32A.

See IAS 40.79.

Lorentzon, J. (2011)Att värdera tillgångar- verkligt värde inom skogs-och fastighetsbranschen.Göteborg bokförlaget BAS.

b) Selection of an appropriate measurement basis according to ED/2015/3

Investment properties contribute to future cash flows in a direct way either by the sale of the investment property or by generating rents from the use of the asset. This is quite a strong argument in favour of choosing a current value measurement basis as the relevance of financial information is enhanced.69 Investment properties are differentiated from owner-occupied properties which are integrated in one way or another in the production process. Accordingly that is not an argument for using cost basis. Nevertheless, also an important aspect of the relevance is the measurement uncertainty; with high measurement uncertainty, an estimate is less relevant.70 Thus there is a tradeoff between measurement uncertainty and relevant information.70 Therefore, current values are only preferable if they provide the most relevant information. In addition, information must be both relevant and faithfully represented if it is to be useful.72

Investment properties are examples of non-financial assets. Prior research indicates that the relevance of fair values is less for this category of assets, due to difficulties collecting information from active markets.73 If fair values cannot be observed, valuation techniques (sometimes including the use of cash-flow-based measurements) may be needed to estimate the fair value.74 In those cases there is a risk that the inputs into the process may be subjective and it may be difficult to verify both the inputs and the validity of the process itself.74 As a consequence comparability may be reduced. These are important factors to consider when choosing measurement basis for investment properties. In those cases where there are difficulties collecting information from an active market there are strong arguments in favour of using cost model.

Thus, according to the criteria for choosing the most appropriate measurement basis, only those investment properties might qualify for the use of current value measurement whose fair values can be derived from active markets. In the other cases there are quite strong arguments for measuring investment properties at (amortised) cost.

See ED/2015/3. chapter 6.54.

See ED/2015/3. chapter 2.13.

See ED/2015/3. chapter 2.13.

See ED/2015/3. chapter 2.20.

Hitz, J-M. (2007) The Decision Usefulness of Fair Value Accounting – A Theoretical Perspective.European Accounting Review,16(2), pp. 323–362.

See ED/2015/3. chapter 6.32.

See ED/2015/3. chapter 6.32.

c) Recognition of gains and losses from fair value adjustments in the other comprehensive income according to ED/2015/3

Only the investment properties which qualify for the use of the current value measurement basis according to ED/2015/3 are subject of this section. The fair value changes of those investment properties are examples of income and expenses that would not arise with historic cost. Therefore the first condition for inclusion of these fair value changes in the other comprehensive income is fulfilled.76 As a second prerequisite, the relevance needs to be enhanced by excluding the fair value changes from the p/I-statement.77 Reporting holding gains in the p/I-statement may cause irrelevant fluctuations in the net income, especially if the investment property is held for a longer time and not intended for an immediate sale. As the prices could change in the future, recognizing gains and losses from fair value changes can create irrelevant profit and loss changes. Especially if the company’s core business is to manage investment properties and the investment properties represent a vast majority of the total assets. In those cases fair value changes may affect reported income substantially. This will make the information less transparent and more difficult to compare for investors. An additional argument for excluding these fair value changes from the p/l-statement might also be the existence of measurement uncertainty which especially exists in the case if the fair values can not be derived from an active market.

If income or expenses are included in the other comprehensive income in one period, there is a presumption that there exists a clear basis for identifying the period in which reclassification would enhance the relevance of the information in the p/l-statement.78 For investment properties a clear basis when they can be reclassified to the p/l-statement can be identified. Depart from sustainable asset impairments, the realization of gains and losses on investment properties will be realized in the period when the properties are sold.

The gains or losses from the sale would be recognised in the p/l-statement in the same way as when assets are measured at historical cost. This procedure will enhance the understandability and comparability of the financial reporting because reported income and expenses will not be distorted by unrealized gains or losses and the information in the income statement will be more useful for estimating the future development of the company.

See ED/2015/3. chapter 7.24a) and in section I.2.

See ED/2015/3. chapter 7.24b).

See ED/2015/3. chapter 7.27.

4 Measurement of biological assets

a) Current situation

Biological assets is a category including a variety of assets from vegetables and living cattle to standing timber. According to IAS 41.10 IFRS applying entities have the accounting choice to measure biological assets after initial recognition at fair value less selling costs or at cost less accumulated depreciations and accumulated impairment losses. According to IAS 41.30 biological assets initially recognised at cost, must be measured at fair value as soon as they can be estimated reliably.79 A company that has measured a biological asset at fair value must continue to measure at fair value until the asset is sold.80 Gains and losses due to changes in fair value, are recognized in profit or loss.81

See IAS 41.30.

See IAS 41.31.

See IAS 41.26.

b) Selection of an appropriate measurement basis according to ED/2015/3

Initially it has to be analyzed under what conditions biological assets qualify for current value measurement. ED/2015/3. chapter 6.54 includes factors important to consider when selecting a measurement basis. One important aspect is if and how the asset contributes to future cash flows (e.g. producing cash flows in a direct way by selling the asset vs. producing cash flows by the use of the asset in the entity’s production process and the sale therefrom generated goods or services). If assets only in combination with other assets produce cash flows and/or variations of cash flows are caused more by risks inherent to the assets than to changes in market factors, historical cost basis should be applied.

Measurement uncertainty is also an important factor to consider when selecting the appropriate measurement base. The most important criterion is to provide as relevant information as possible. Nevertheless, with high measurement uncertainty, an estimate is less relevant.82 Most important is to consider what measurement base provides the most relevant information by an acceptable degree of measurement uncertainty.

Biological assets represent a wide range of assets.83 These assets are fundamentally different; the life cycle of living animals may be as shorts as a few month and for standing timber as long as 120 years. In both cases the asset is a part of the production process until it can be harvested; this speaks in general for using a cost basis. It is true that there are market places for some biological assets at different maturity for example piglets. But in most cases the asset must mature until the asset will be demanded in the market. Another aspect is how the asset contributes to cash flows. If for example the idea is to refine the standing timber to other products, there is no intention selling the timber in the market. If the standing timber is not for a direct sale, maybe the standing timber should be regarded to produce cash flows only by the use of the asset in the entity’s production process. According to ED/2015/3 it would be a strong argument for cost basis. It is also a fact that early in the production process historic cost and the fair value will be similar. According to ED/2015/3. chapter 6.49 information must be relevant and it must faithfully represent what it purports to represent. As mentioned earlier this is due to the fact that it takes some time before the asset has such qualities demanded in the market. From this perspective historic cost will better fulfill the requirements of ED/2015/3. chapter 6.49 than current values and as well provide more relevant information to investors. Therefore fair value changes of the biological assets should be ignored until they are realized or by other retirement or a preceding sustainable asset impairment.

In those cases the biological assets are for direct sale and/or the market values can be estimated reliably they may qualify for current value measurement. This is true for example standing timber and living animals when they produce cash flows by their own and are not integrated in the entity’s operating activities.

See ED/2015/3. chapter 2.13.

See section II. 4 a).

c) Recognition of gains and losses from revaluation in the other comprehensive income according to ED/2015/3

If biological assets qualify for the use of a current value measurement basis, especially the fair value, the changes in the fair value could only be included in other comprehensive income if the conditions in ED/2015/3 chapter 7.24 are met: the fair value changes are examples of income and expenses that would not arise with historic cost and the relevance is enhanced.

Biological assets fulfill the first criterion since changing prices are examples of income and expenses that would not arise with historic cost. Furthermore the relevance needs to be enhanced. For some biological assets there are quite strong arguments for enhanced relevance. One example is biological assets with shorter life cycle such as living cattle. Another is standing timber when prices can be derived from an active market. It is true that in some companies biological assets represent a great proportion of the balance sheet, for example standing timber. In those cases value changes may affect reported income substantially. This may affect the financial information less transparent and more difficult to use for economic-decision-making. It will still be preferable to recognize gains and losses in the other comprehensive income compared to p/l-statement because reported income will not be distorted.

Another prerequisite is that income or expenses included in other comprehensive income in one period will be included in p/l-statement in some future period.84 In general, there must be a clear basis for identifying the period in which reclassification would enhance the relevance of the information in p/I-statement.85

For assets with a long life cycle, for example standing timber, it may be difficult to identify a specific future period when the relevance of the information will be enhanced in the p/l-statement. Nevertheless, a reclassification of the other comprehensive income to the p/l-statement could enhance the relevance of information in the p/l-statement in the period the standing timber is harvested. Thus one suggestion is to reclassify to the p/l-statement in the period when the asset is harvested or sold. For assets with a shorter production cycle, for example vegetables and living cattle, it is easier to identify a future period in which relevance would be enhanced by reclassification.

ED/2015/3. chapter 7.26.

ED/2015/3. chapter 7.27.

III SUMMARY

ED/2015/3 is a decisive step towards the future CF. Most remarkable are the IASB’s suggestions regarding the measurement of items of the statement of financial position and the delineation of the other comprehensive income. This article analyzes the potential impacts of these proposals of some items that are at present measured at fair value. The results are as follows:

  • Only a part of the tangible and intangible assets for which the existing IAS 16 and IAS 38 contain the accounting choice for revaluation fulfill the criteria for selecting a current value as measurement basis. Furthermore, according to the proposals of ED/2015/3. chapter 7.23–7.27 the fair value changes of the tangible and intangible assets which qualify for the use of a current value as measurement basis have to be recognised in the other comprehensive income which will be reclassified to profit or loss because there exists a clear basis for identifying the period in which reclassification would enhance the relevance of the information in the p/l-statement (especially the period of sale or other disposal).

  • Although the equity instruments not held for trading qualify also for the use of a current value measurement basis according to the proposals of ED/2015/3, nevertheless the option to recognise fair value changes of these equity instruments in the other comprehensive income which will not be reclassified to profit or loss could not be justified due to the criteria of ED/2015/3. chapter 7.23–7.27.

  • For investment properties current value measurement should only be used for those investment properties whose fair values can be derived from active markets. In the other cases there are strong arguments for historic cost. For investment properties which qualify for current value measurement, the prerequisites for recognition of gains and losses in the other comprehensive income which will be reclassified to profit or loss are met.

  • Biological assets represent a variety of assets with very different life cycles. In most cases the asset must mature until it is demanded in the market. In many cases the biological asset is part of the production process. In those cases historic cost better fulfil the criteria of ED/2015/3. Only in those cases the biological asset is for a direct sale and/or the prices can be derived from an active market, they qualify for current value measurement. For biological assets with a long life cycle it may be difficult to identify a period when a reclassification would enhance the relevance of the information in the p/l-statement. Though, one suggestion is to reclassify when the asset is harvested or sold. For assets with a shorter production cycle it is easier to identify a future period in which relevance would be enhanced by reclassification.

From all this follows, the potential impacts of the future CF are remarkable and it has to be expected that after finalising the CF not only a few IAS/IFRSs will be reviewed and probably revised. Due to the analysis presented in this article it could be expected that the trend of the last two decades in IFRS accounting towards an increasing importance of fair value accounting will be stopped and maybe partly reversed. In addition, also the trend of the last decade in IFRS accounting towards an increasing number of items included in the other comprehensive income which will not be reclassified to profit or loss will significantly be reversed due to the refutable presumptions of ED/2015/3. chapter 7.26 f.

Hanno Kirsch is Präsident der Fachhochschule Westküste and professor at the Europa-Universität Flensburg, Germany. Johan Lorentzon is PhD at Karlstads University, Sweden.