IASB-FASB Update Report to the FSB Plenary on Accounting Convergence

5 April 2012

Hans Hoogervorst
Chairman, International Accounting Standards Board

Leslie F. Seidman
Chairman, Financial Accounting Standards Board

Summary

1. In 2006 the IASB and the FASB (the boards) agreed on a Memorandum of
Understanding (MoU) that identified the short-term and longer-term convergence
projects that would bring the most significant improvements to IFRSs and US GAAP.
The MoU was updated in 2008.

2. The boards are close to completing the MoU programme:

 Most of the short-term projects identified for action have been completed or are
close to completion and one has been determined to be a lower priority.

 Of the longer-term projects, several have been completed and there are three of
the originally identified projects for which the boards have yet to finalise the
technical decisions—leases, revenue recognition and financial instruments.

3. In our previous report we indicated that neither board would issue a new standard until
it had first considered whether re-exposure was necessary; secondly, that it had
considered the feedback on the proposed final standard; and thirdly, that it was
satisfied that the standards were operational. In mid-2011, the boards jointly
announced that they had decided to re-expose both the revenue recognition and leases
proposals. This decision was made in response to feedback from a broad range of
global constituents who raised concerns about the significant impact these standards
would have on financial reporting. While formal decisions have not been made by the
boards on classification and measurement and impairment of financial instruments,
taking into consideration the significance of the changes that these projects propose,
we expect that they will also be re-exposed.

4. The IASB and the FASB are continuing to work expeditiously on reaching converged

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solutions on our financial instruments, leases, and insurance projects. However, that
work is being undertaken at a pace that enables thorough consultation to be undertaken
with a particular focus on ensuring that potential solutions are operational. We expect
that we will begin redeliberations of our joint project on revenue in the second quarter
of 2012 and that we will re-expose our projects on classification and measurement,
impairment and leases in the second half of 2012. We expect to issue final standards
on these projects by mid- 2013.

5. Delays in completing these much-needed improvements to financial reporting are

unfortunate, but necessary to ensure that any changes are operational and will bring
about an improvement to financial reporting in these important areas. It is incumbent
on the boards to ensure that changes made to our accounting requirements are
appropriate, that our stakeholders have had the opportunity to fully participate in the
process, and that the boards have been responsive in considering stakeholder feedback
in the process. Re-exposure, in this case, is part of that process.

Update

6. The boards are continuing their efforts to achieve a single set of high quality,
global accounting standards, within the context of an independent standard-setting
process.

7. The MoU identified the short-term and longer-term projects that the boards
agreed would bring the most significant improvements to IFRSs and US GAAP.

8. In 2010, with the support of the international community, the boards set priorities
for the projects that would make the most significant improvements to IFRSs and
US GAAP.

Short-term projects

9. Most of the short-term projects required one of the boards to revise its
requirements to better align them with those of the other board—eg the IASB
revised segment reporting to align it with US GAAP. Other projects, such as
share-based payments, required both boards to issue revised standards.

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Project Status Milestone

Share-based payments Completed Converged standards issued in 2004.
Segment reporting Completed IFRS 8 Segment Reporting issued in 2006.
Non-monetary assets Completed The FASB converged the treatment of
certain nonmonetary exchanges to require
recognition at fair value unless the
transaction lacks commercial substance in
FAS 153, Nonmonetary Assets issued in
2004.
Inventory accounting Completed The FASB converged the treatment of
excess freight and spoilage in FAS 151,
Inventory Costs issued in 2004.
Accounting changes Completed The FASB converged the treatment of
voluntary changes in accounting policy by
requiring retrospective application in
FAS 150, Accounting Changes and Error
Corrections issued in 2005.
Fair value option Completed Fair value option for financial instruments
introduced into US GAAP in 2007.
Borrowing costs Completed Revised IAS 23 Borrowing Costs in 2007.
Research and Completed US GAAP amended for acquired R&D, as
development part of business combinations, in 2008.
Non-controlling Completed Mezzanine presentation eliminated from
interests US GAAP, as part of business
combinations, in 2008.
Joint ventures Completed IFRS 11 Joint Arrangements issued in May
2011. Establishes principles for the
financial reporting by parties to a joint
arrangement.
Income tax Reassessed as a Joint exposure draft published in 2009.
lower priority
project. No The IASB may consider a fundamental
immediate review of the accounting for income taxes
action. at a later date.

Investment property In process The FASB issued a proposal to require

entities investment property entities to measure
their investment properties at fair value.

Long-term projects

10. The MoU was updated in 2008, at which time the boards narrowed down the
programme to focus on ten longer-term projects. The boards have worked
successfully to complete most of the projects in the updated 2008 MoU:

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Project Status Milestone

1 Business combinations Completed Joint requirements for business
combination accounting and
non-controlling interests issued in 2008.
2 Derecognition Completed Each board has introduced reforms
substantially aligning the disclosure
requirements and bringing US GAAP
accounting requirements closer to IFRSs.
3 Consolidated financial Completed IFRS 10 Consolidated Financial
statements (including Statements and IFRS 12 Disclosure of
disclosure about Interests in Other Entities issued in May
off balance sheet risks) 2011.
The FASB issued proposed clarification
relating to principals vs. agents in 2011.
4 Fair value Completed FASB Statement No. 157 Fair Value
measurement Measurements issued in 2006.
IFRS 13 Fair Value Measurement issued in
May 2011.
5 Post-employment Completed Amendments to IAS 19 Employee Benefits
benefits issued in 2011.
6 Financial statement Completed Amendments to IFRSs and US GAAP for
presentation—other presentation of other comprehensive
comprehensive income income issued in 2011.
7 Financial instruments Reassessed as a Joint discussion paper published in 2008.
with the characteristics lower priority
of equity project.
8 Investment entities IASB and FASB The IASB’s proposal would exempt a class
published of entities whose substantive activity is
proposals in investing for capital appreciation,
August and investment income, or both from
October 2011, consolidating entities they control. Instead,
respectively. these investment entities would measure
controlled investees at fair value, with any
changes in fair value recognised in profit or
.
loss.
The FASB’s proposal would amend the
existing guidance in US GAAP for
investment companies to develop
converged criteria for assessing whether an
entity is an investment company.

11. Today there are only three longer-term priority MoU projects for which the
boards have yet to finalise all of the technical decisions—Financial instruments,
Revenue recognition and Leases. The timelines on revenue recognition and
leases were extended at the request of many stakeholders to ensure that their
interests could be given full consideration. Although the MoU projects have been

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given priority, the boards have also been working together on much-needed
improvements to the accounting for Insurance contracts.

Project Status Milestone

1 Leases In process Having exposed joint proposals in August
2010, the boards plan to publish revised
proposals in the second half of 2012 that
respond to the extensive consultation
undertaken.
2 Revenue In process The boards exposed joint proposals in June
recognition 2010. The comment period for the revised
proposals that respond to the extensive
consultation undertaken closed in March 2012.
The boards expect to complete their
discussions in 2012.
3 Financial In process Described in the financial instruments section
instruments of this document.
4 Insurance contracts In process The boards are working towards their next
publications for the second half of 2012. The
IASB is considering whether it should publish
another exposure draft (ED). Doing so would
align the boards’ consultative processes
because the FASB has yet to publish an ED.

Status of the work plan

12. The IASB and FASB remain committed to completing the remaining three MoU
projects—financial instruments, revenue recognition and leases—as well as
insurance contracts, as expeditiously as possible.

13. The next sections of this report describe in more detail the status of the individual
projects and the steps that the boards plan to take to complete the MoU
programme.

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Financial instruments

Classification and measurement

IASB

14. The IASB completed the classification and measurement chapters of IFRS 9
Financial Instruments in 2009 for financial assets and in 2010 for financial
liabilities. IFRS 9 has resulted in simplifying the classification and measurement
model for financial assets to two categories (amortised cost and fair value) with a
single impairment model. Tainting rules are eliminated and embedded derivatives
are no longer required to be separated from their financial asset host contract.

15. The volatility in profit or loss resulting from fair value measurement of a
company’s own debt is addressed by requiring such gains and losses to be
recorded within Other Comprehensive Income (OCI).

16. In December 2011, consistently with its commitment to ensure that entities are
able to apply all phases of IFRS 9 simultaneously, the IASB deferred the
mandatory date of IFRS 9 from 2013 to 2015. Early adoption is still permitted.

FASB

17. In 2010 the FASB published an exposure draft addressing the classification and
measurement of financial instruments, impairment accounting and hedge
accounting. The FASB’s exposure draft proposed a much greater use of fair value
measurement than does IFRS 9, with almost all financial instruments on the
balance sheet at fair value. The proposal included an amortised cost option for
certain financial liabilities.

18. Responding to the feedback received on the exposure draft, the FASB tentatively
decided that at least some assets should qualify for amortised cost accounting,
based on the business activity the entity uses to manage those financial assets.
The FASB has tentatively decided that three different business strategies are
relevant to the classification of financial assets and have tentatively decided that
bifurcation of financial instruments should be retained. The FASB also
tentatively decided that financial liabilities would be measured at amortised cost

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unless the business strategy for the financial liability at acquisition, issuance, or
inception is to subsequently transact at fair value, or to sell in a short sale. Those
financial liabilities would be classified at fair value through net income.

NEXT STEPS

19. As noted above, the boards have reached different answers on matters such as the
number of classification categories, which assets should be measured at fair value,
where fair value changes should be recognised and the bifurcation of embedded
derivatives. In addition, there are important legacy differences, such as whether
items measured through other comprehensive income should be recycled to net
income when they are sold.

20. The IASB and the FASB have consistently received feedback from stakeholders
to the effect that every effort should be made to make their respective financial
instruments accounting standards converge. In November 2011 the IASB agreed
to consider modifying IFRS 9, particularly in view of convergence and the
insurance contracts project. The IASB noted that any changes should be made in
a manner that minimises disruption for those who have already started to apply or
were close to applying IFRS 9.

21. At the January 2012 joint meeting, the IASB and the FASB agreed to jointly
consider ways in which their models could be better aligned. The boards are
planning to discuss key areas of differences over a series of public board meetings
through the second quarter 2012.

22. The boards will focus on discussing: which instruments are eligible for amortised
cost (ie contractual cash flow characteristics and business model criteria); the
need for bifurcation of financial assets, and, if pursued, the basis for bifurcation;
the basis for and scope of a possible third classification category (debt instruments
measured at fair value through other comprehensive income); and any knock-on
effects (for example, disclosures or the model for financial liabilities given the
financial asset decisions).

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23. At the February 2012 meeting the boards tentatively agreed to the same
contractual cash flows test, which removed a significant difference between their
models.

24. The boards are continuing their deliberations and expect to be in a position to
issue exposure drafts in the second half of 2012, and to finalise new standards in
the first half of 2013. Owing to the different stages of development, the boards
propose that any exposure drafts should be separate but achieve as converged an
outcome as possible.

25. In addition, in response to significant investor feedback, the FASB has proposed
several new disclosures requirements: sensitivity analysis, information about
liquidity, asset/liability mismatches, etc. These requirements are based on IFRS 7
Financial Instruments: Disclosures, but are more expansive, and would require
standardised formats. The FASB plans to expose them separately in the second
quarter of 2012, before the classification and measurement changes.

Impairment

26. The IASB and the FASB are continuing to address the main criticism of an
incurred loss impairment model that was highlighted during the financial crisis.
The boards are jointly developing a more forward-looking ‘expected loss’
approach to impairment (also known as loan loss provisioning). The IASB
published an initial exposure draft of proposals in 2009. The FASB’s 2010
exposure draft on financial instruments proposed a different expected loss model.
Stakeholders responded that reaching a common impairment solution is very
important. The IASB and the FASB subsequently published supplementary joint
proposals in 2011 and continue to jointly develop a common impairment model.

27. The boards are pursuing a model with an overall objective of reflecting the
deterioration in the credit quality of financial assets. The boards have focused on
an approach that places financial assets into three categories (or ‘buckets’) for the
purpose of assessing the timing of recognition of expected losses. The
impairment loss recognised would vary depending on which category an asset is
allocated to. Generally, 12 months of expected losses are recognised on initial

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recognition. If an asset deteriorates in credit quality and the credit quality is

below a certain level, the asset would be reclassified to another category and a
lifetime loss allowance would be recognised. Disclosures will be critical to
support the principle-based impairment model and ensure comparability between
entities.

28. The boards and staff continue to perform extensive joint outreach to determine
whether the proposed approach is operational. The boards are discussing how the
proposed model would apply to certain financial instruments and what disclosures
should be required. The boards have been consulting widely with, among others,
prudential supervisors and members of the IASB’s Expert Advisory Panel of
credit risk experts who provide guidance on the operational considerations of the
proposals.

29. Reaching a converged solution is of the utmost importance. The boards have had
to balance the urgency of the project with the need to ensure that any new
requirements are operational, will be applied consistently and will produce high
quality information. The broad consultation has shown that current practices
diverge widely and that any solution will cause significant changes for at least
some major participants in the financial sector.

30. The current plan is to complete joint deliberations and issue converged exposure
drafts in the second half of 2012. On the basis of that timetable, we would target
finalisation of the new impairment requirements to be achieved in the first half of
2013.

Hedge accounting

General hedge accounting

31. The boards had differences in scope in their original hedge accounting projects.
The IASB proposed a fundamental overhaul of hedge accounting to tie in with
risk management and make hedge accounting more accessible for corporates
(non-financial institutions). The FASB had a more focused approach dealing with
narrower practice issues in their hedge accounting requirements. Because of the
scope differences, the boards originally decided to work separately, with the

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FASB inviting its constituents to comment on the IASB’s document as well as its
own.

32. The IASB published its exposure draft in 2010. In 2011, the IASB completed its
redeliberations on its exposure draft. A review draft will be posted on the IASB’s
website for 90 days in the first half of 2012, during which time the IASB will
undertake an extended fatal flaw review and outreach activities. The IASB is
targeting a final standard to be issued in the second half of 2012.

33. The FASB plans to consider whether to expand its evaluation of hedge accounting
issues. The FASB will begin redeliberations on the hedge accounting model once
the deliberations on classification and measurement are complete, to ensure that
the interaction of these decisions on a potential hedge accounting model is clear.
As part of this process, the FASB will continue to evaluate the feedback received
on the FASB’s 2010 exposure of its hedge accounting proposals and the feedback
and decisions reached on the IASB’s general hedge model.

Macro hedge accounting

34. The IASB is currently developing proposals to address risk management

strategies involving open portfolios (macro hedging) that are not dealt with by the
general hedge accounting model. The IASB’s deliberations consider the feedback
received on the general hedge accounting model. The IASB expects to publish a
discussion paper or an exposure draft of proposals in the second half of 2012.

Offsetting (netting) derivatives and other financial instruments

35. In response to stakeholders’ concerns (including those of the Basel Committee on

Banking Supervision and the Financial Stability Board) regarding the
comparability of entities using IFRSs and US GAAP, the IASB and FASB
decided to expand the scope of the joint project on financial instruments to
address netting or offsetting financial assets and financial liabilities on the
statement of financial position (balance sheet). Offsetting (or netting)
requirements are the source of significant differences between the balance sheets

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of financial institutions using US GAAP and those using IFRSs. A common

solution would be of great assistance to regulators and other users of financial
statements.

36. In early 2011, the boards published proposals to align their requirements for when
financial assets and financial liabilities are set off, or netted, in the statement of
financial position. The proposed model focused on netting on the basis of the
ability and intention to offset payments in the normal course of business and in
times of stress. This was closer to the requirements in IFRSs than to US GAAP,
which, for derivatives, gives primacy to the ability to offset in bankruptcy.

37. In June 2011 the IASB and FASB reached different conclusions. The FASB
decided not to proceed as proposed based on the feedback that they received on
the proposals. The IASB initially reaffirmed the proposals in the exposure draft
but ultimately decided to maintain its existing offsetting requirements. However,
to assist users of financial statements, the boards agreed on common disclosure
requirements. These disclosures will provide users with comparable information
on amounts that are offset and subject to offsetting arrangements for financial
statements prepared in accordance with IFRSs and US GAAP.

38. The boards issued final requirements in December 2011. These requirements are
effective for periods beginning 1 January 2013.

39. In addition, in December 2011 the IASB issued additional application guidance to
IAS 32 Financial Instruments: Presentation, to clarify inconsistencies in
offsetting practice that were identified during the comment period.

Accounting for Repurchase Agreements (FASB)

40. In March 2012, the FASB formally announced a project to address the accounting
for repurchase agreements. Among the issues that the new project will consider is
whether repo-to-maturity transactions should be reflected on the balance sheet as
financings instead of being treated as off-balance sheet sales and whether
enhanced disclosures are necessary. Under IFRS 9, repo-to-maturity transactions
are generally accounted for as secured borrowings.

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Revenue recognition

41. As we previously stated in our report to you in October 2011, after considering
the feedback they had received on the exposure draft, the boards decided to re-
expose their revised proposals. It was the unanimous view of the boards that,
while there was no formal due process requirement to re-expose the proposals, it
was appropriate to go beyond established due process, given the importance of the
revenue number to all companies and the need to take all possible steps to avoid
unintended consequences. Consequently, the boards have now issued three due
process documents: a discussion paper in December 2008, an exposure draft in
June 2010 and a revised exposure draft in November 2011.

42. The project is critical to both the FASB and the IASB. US GAAP has a wide
range of industry-specific requirements that are acknowledged to be inconsistent.
The IASB’s standard does not have any application guidance and preparers often
look to US GAAP for specific guidance. The project is intended to reduce the
FASB’s detailed guidance to consistent principles and to remove the need for
IFRS users to refer to US GAAP.

43. In November 2011 the boards issued a revised exposure draft with a
comprehensive principle and application guidance for when and how to recognise
revenue. The revised exposure draft reaffirms the principle for revenue
recognition from the first exposure draft (issued June 2010) but, in response to the
feedback received, amends the proposals to reduce complexity and add clarity to
the basic concepts. The 120-day comment period ended in March 2012.

44. The boards have taken a number of steps to inform stakeholders about the revised
proposals. The IASB’s and the FASB’s websites contain a webcast explaining
the major provisions, a webcast answering frequently asked questions, and a
reference tool comparing current requirements with the proposed requirements
and highlighting the industries that would be affected. Extensive outreach has
been undertaken with stakeholders around the globe to help them understand the
proposal and formulate their views. Round-table meetings and discussion forums
will take place in the second quarter of 2012 in Europe, North America, Asia and
South America.

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45. The boards expect to begin joint redeliberations in the second quarter of 2012.
Substantive deliberations are expected to be completed in 2012 with a final
standard expected to be issued in early 2013.

Leases

46. Lease obligations are widely considered to be a significant source of off balance
sheet financing. The objective of this project is to improve financial reporting by
ensuring that all assets and liabilities arising from lease contracts are recognised
in the statement of financial position.

47. In August 2010, the boards issued an exposure draft proposing that the rights and
obligations relating to leases should be reported on a lessee’s balance sheet. The
proposed accounting for lessors was designed to ensure that an entity that retains
significant risks or benefits of the leased asset would recognise that asset and an
associated obligation to allow the lessee to use the asset. In other cases, ie when
the significant risks or benefits of the leased asset are transferred to the lessee, the
lessor would derecognise the portion of the asset that is transferred by the lease
agreement.

48. During 2011 and 2012 the IASB and FASB have been considering the
comments received on the exposure draft. In July 2011 the boards decided
that, although they had not completed all of their deliberations, they had
sufficient information to be able to conclude that they should re-expose the
leases proposals.

49. Although the boards have addressed many of the issues raised by respondents
to the exposure draft, we are aware of some remaining concerns about whether
all leases should be accounted for in the same way. For example, some have
questioned whether the profit and loss profile for lessees, which tends to be
‘front loaded’, is appropriate for all leases. While the redeliberations are
substantially complete, the boards are reconsidering the appropriate profit and
loss profile for lessees in light of feedback already received (ie before
publishing the new exposure draft). The more fundamental issue of the

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recognition of assets and liabilities on the balance sheet is not being

reconsidered.

50. In January 2012 the leases working group was convened to discuss this issue.
At the February 2012 meeting, the boards used the input received from the
working group to further discuss lessee accounting and, in particular, different
methods of amortising the so-called right-of-use asset recognised by lessees.
The boards asked the staff to perform further outreach on those different
methods to assess their operationality and usefulness for users of financial
statements. The staff will report back to the boards in the second quarter of
2012.

51. The boards are targeting completing deliberations and issuing exposure drafts in
the second half of 2012. During the comment period, the boards plan to conduct
additional outreach with users of financial statements and entities that undertake
lease activities. We expect a final standard in mid-2013.

Other projects

Insurance contracts

52. ‘Insurance contracts’ has been an active project for the IASB since the IASB was
formed in 2001. It is an important project because IFRSs currently lack specific
accounting requirements for insurance contracts. In 2007 the IASB published a
discussion paper, Preliminary Views on Insurance Contracts. In October 2008
the FASB added a project on insurance contracts to its agenda and the boards
agreed to undertake it jointly. The FASB and the IASB are at different points in
the process on the insurance contracts project. The IASB issued an exposure
draft, Insurance Contracts, in July 2010. The FASB published a discussion
document of its own, which included alternative views, in September 2010.

53. In 2011, the boards began considering together the feedback received on the
IASB’s exposure draft and the FASB Discussion Paper. In general, the boards are
developing a model that would reflect current estimates of the amount necessary
to fulfil an insurance obligation. However, the boards have not reached consistent

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conclusions about several elements of the model. There is a strong desire for a
global standard on insurance, and the boards are undertaking an effort to gain a
deeper understanding of the decisions taken by each Board to identify potential
opportunities to resolve differences. The boards currently estimate that they will
conclude the major technical discussions in the second quarter of 2012, with a
FASB exposure draft in the second half of 2012. The IASB is considering
whether it should publish another exposure draft or proceed to a final IFRS.
Issuing an exposure draft would align the boards’ consultative processes. On the
basis of this plan, final standards could be issued in 2013.

Consolidation

54. The boards have completed their respective consolidation projects, which
included addressing issues about the consolidation of special purpose entities and
enhanced disclosures about off balance sheet risks. The new IFRS requirements
will also bring into force new disclosure requirements relating to structured
entities (special purpose entities), making IFRS and US GAAP disclosure
requirements similar.

55. Differences remain, however, in relation to what US GAAP refers to as voting

interest entities; US GAAP has a legalistic approach to defining control, whereas
the new IFRS has a broader definition of control, including effective control. On
the basis of feedback received, the FASB also decided to expose the
principal-agent sections of the IFRS model.

Investment entities

56. The boards are also seeking to align the criteria for determining whether an entity
is an investment company or investment entity whose substantive activity is
investing for capital appreciation, investment income, or both.

57. The project objective is to define an investment entity and to require that an
investment entity should not consolidate investments in operating entities that it

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controls, but should measure those investments at fair value, with changes in fair
value recognised in profit or loss.

58. The IASB published its proposals, which were developed with the FASB, in
August 2011. The IASB’s proposal provides an exception to the consolidation
principle and equity method guidance for a particular class of entities—
investment entities (which would result in measuring controlled investees and
investments over which the entity can exercise significant influence at fair value
through profit or loss).

59. The FASB exposure draft was issued in November 2011. The FASB’s proposal
would largely converge the criteria to determine whether an entity is an
investment company with the IASB’s proposal. Current US GAAP provides
complete accounting and reporting guidance for investment companies. Under
current US GAAP, an entity that meets the criteria to be an investment company
would be required to measure all of its investments at fair value with all changes
in fair value recognised in net income.

60. The boards plan to commence joint redeliberations of their proposals in the
second quarter of 2012. On the basis of this timing, a final standard is targeted
for the end of 2012.

Agenda consultation (IASB)

61. In addition to finalising the MoU projects, the IASB is working on topics for
its future technical agenda. On 26 July 2011 the IASB launched its first formal
public agenda consultation on its future work plan. Comments were requested
by 30 November 2011. Through the agenda consultation, the IASB is seeking
input from all interested parties on the strategic direction and the broad overall
balance of the work plan. The agenda consultation will provide the IASB with
important input when considering possible agenda items.

62. In January 2012 the IASB discussed the staff's summary of feedback received
on the agenda consultation. The staff did not make any recommendations and
the IASB was not asked to make any technical decisions. The IASB requested

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that the staff should do further research to clarify some matters raised in the
comment letters and suggested further ways in which the priorities for
standards-level projects could be assessed. The IASB expects to discuss a
development plan in the second quarter of 2012.

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