IFRS Update A discussion on the recent changes to IFRS and the road to convergence with US GAAP

IFRS Update

A discussion on the recent changes to IFRS and the road to convergence with US GAAP

Speakers

• Colm Homan, Partner, PwC

• Anna Burns, Senior Manager, Deloitte & Touche

• James Berry, Director, KPMG

Moderator

• Tom Kelly, Partner, KPMG

Agenda

• What is IFRS

• US Regulatory Developments

• Insurance Contracts

• Financial Instruments

• IFRS 1, First-time Adoption of International Financial Reporting Standards

• IAS 37, Provisions, Contingent Liabilities and Contingent Assets,

What is IFRS

International Financial Reporting Standards (IFRS)

• IFRS is a high-quality, comprehensive, globally-accepted set of accounting standards

• In many instances, IFRS contains similar concepts to U.S. GAAP

• IFRS is a less extensive body of literature than U.S. GAAP, with limited industry-specific guidance and less detailed application guidance

• There are more circumstances where application of IFRS will require exercise of judgment, supported by contemporaneous analysis and documentation

• IFRS requires transparent disclosures in the financial statements of critical accounting policies and estimates, particularly in areas requiring application of judgment

What is IFRS

Joint IASB/FASB efforts

• Convergence continues, with the following key joint projects: revenue recognition; financial statement presentation; lease accounting; financial instruments; derivatives and hedging; de-recognition; consolidation; and fair value measurement

Worldwide

• Over 100 countries either require or allow IFRS (or a national variant) for listed companies

• Other countries have plans to adopt or converge to IFRS by 2011:

– Brazil, Canada, Chile, India, Mexico, Singapore, South Korea

– Japan: optional early adoption for FY 2010 and possible mandatory adoption by 2016

What is IFRS

Bermuda

• IFRS conversion activity is mainly focused in the following areas:– Several large reinsurance companies are assessing the impact of

converting from US GAAP to IFRS due to the SEC roadmap/work plan and Solvency II

– Public interest entities (includes listed companies and local insurers) who currently prepare financial statements under Canadian GAAP have to prepare IFRS financial statements from 2011

RoadmapNov 17, 2008

Comment lettersApr 20

“We need a single set of

global standards”

Regulatory

ReformJune 17


global standards”

G20 London SummitApr 2


global standards”

G-20 Pittsburgh Summit

Sep 24-25

“We call on international accounting

bodies to develop a single set of standards by June 2011”

Mary Schapiro speech at IOSCO Oct 8

“I am committed to focusing our efforts this fall to following up with a work plan that expands upon

the concepts proposed in the

roadmap”

SEC DraftStrategic

Plan Oct 9

We will promote … a single set of

high-quality global

accounting standards

Statement on Global

Accounting Standards

Feb 24

US Regulatory Developments


SEC work plan pointing towards IFRS adoption by U.S. issuers

•February 2010: SEC Statement and work plan in support of convergence and global accounting standards

– SEC reaffirmed its support for a single set of high-quality, globally accepted accounting standards and for the convergence of U.S. GAAP and IFRS

– Statement that IFRS is best-positioned to be able to serve the role as the single set of global standards


Work plan describes 6 specific areas relevant to SEC’s decision on adopting IFRS, including:

•Areas most relevant for SEC’s decision to adopt IFRS: – sufficient development and application of IFRS and– independence of standard setting for the benefit of investors

•Transitional considerations:– investor understanding / education regarding IFRS– examination of how the U.S. regulatory environment would be

affected– Impact on issuers, such as changes to accounting systems,

including evaluation for both large and small issuers and – human capital readiness, such as education and audit capacity


SEC work plan pointing towards IFRS adoption by U.S. issuers (cont’d)

•Next steps

– Beginning no later than October 2010: SEC staff will provide periodic progress reports on work plan

– 2011: SEC will consider whether, and if so, how to incorporate IFRS into the U.S. financial reporting system

– 2015 or 2016: Estimated first time U.S. issuers would be required to report under IFRS; SEC will further evaluate timeline as a part of the work plan

• Possible that early adoption may be allowed for some issuers once decision on IFRS is made

Insurance Contracts

Phase II of the Insurance Standard

• Background

• Tentative Decisions and Timetable

• Potential Impact

Background to Insurance Contracts Project

• Current situation for accounting for insurance contracts is a mixed model• Resulted in too much diversity, less relevance and reliability,

and inconsistency• The IASB started with a clean slate to develop Phase II

2004 2005 2006 2007 2008 2009 2010 2011 2012

Discussion paper

published

May 2007

Comment period closed

Nov 2007

Phase II Exp Draft

July 2010

Phase II final

standard

June 2011

Phase II IFRS

effective

2012/13+

Phase II work

begun

Jul 2004

We are hereFASB joins project

Insurance Contracts Project

The FASB joined with the IASB for Phase II of the IFRS 4 – Insurance Contracts project• Purpose – comprehensive financial reporting standard for Insurance

contracts (life and non-life) • It is expected that the outcome of Phase 2 will become US GAAP

irrespective of if and when there is overall convergence of US GAAP and IFRS

Current Timetable• IASB and FASB are committed to July 2010 Exposure Draft, with a

comment deadline of 3 months. FASB have not concluded as to whether they issue a DP or ED.

• Final IFRS standard is due by June 2011 (when key IASB membership turns over)


•Background

•Tentative Decisions and Timetable

•Potential Impact

Tentative decisions made

Measurement objective and approach

• IASB marginally support a 4 building block approach

- Expected value of cash flows

- Discounting for time value of money

- Explicit risk adjustment

- Residual margin (amount to avoid a day 1 gain)

• FASB in favor of a composite margin

• Both methods likely to be included in exposure draft

IASB and FASB discussions to date

Tentative decisions made

Discounting for time value of money

• IASB and FASB apply discounting, and the discount rate should not be impacted by changes in own credit standing

• IASB- not an asset backed discount rate

• IASB- characteristics of liability

Explicit risk adjustment

• Reflect insurer’s view of uncertainty

• Updated each reporting period

• Additional guidance on measurement tbd



Tentative decisions made (con’t)

Residual margins

• At inception, no day 1 gain

• Subsequent treatment of residual margins being discussed

- Amortized in some predetermined manner

- Not updated each period for experience, i.e., not a “shock absorber”

Unearned/Earned premium expedient for short duration contracts

• Definition of a short duration contract under debate



Acquisition costs

• Include “incremental costs at the contract level” as cash flows in building block model

Unbundling (e.g., deposit vs. insurance vs. service)

• Not required for recognition or measurement if components are significantly interdependent (proposal around notion of significant and interdependent being refined)

Performance statement

• Narrowed view to summarized margin vs. expanded margin

• Most recent vote in favor of summarized margin with supplemental disclosure about volume of business



Reinsurance Accounting

• Generally, follow same approach as insurance accounting

Definition of insurance contract

• Compensation for loss (excluding manufacturer/dealer warranties, fixed service fee contracts)

• Must include significant underwriting or timing risk with proviso to examine certain timing delays

Risk transfer

• IASB and FASB: focus on existence of possible outcomes in which the PV of cash flows is negative


• Background

• Tentative Decisions and Timetable

• Potential impact

Potential impact

Financial reporting

• Earnings volatility as assumption unlocked

• Revised income statement presentation

• Potential for significant additional disclosure

Finance transformation

• Need appropriate resources

• Manage competing projects such as solvency II

• Ensure proper training

• Implement internal controls

Potential impact

Systems requirements

• Actuarial systems may need to provide cash flow projections

• Enhance systems configurations to meet new demands

• May require new or updated ERP implementation

Business issues

• Impact on new product design

• Changes to agent compensation structure to reduce up front commissions

• Planning, budgeting and forecasting impacted

• Educate users of financial information

Financial Instruments



• IFRS 9: Financial Instruments– What does it mean?

• Changes to classification and measurement– Effect on impairment

• IAS 39 replacement timeline

• Exposure Draft: Amortized cost and Impairment

Financial InstrumentsIFRS 9


• IFRS 9: Financial Instruments– Effective for periods beginning on or after January 1, 2013

with early adoption permitted.– New classification and measurement model for financial

assets.– Financial liabilities currently scoped out.

Financial InstrumentsRevised classification and measurement

Financial InstrumentsSo what will change?

Balance sheet volatility

P&L

vola

tility

More

Same

Same

Less

MoreLess

Unquoted equity previously held at cost (elected to FVTOCI)

� Government/corporate bonds managed on a contractual yield basis

� Quoted equity investments (elected at

FVTOCI)

� Trade receivables / payables

� Derivatives� Held for trading

instruments� Issued debt (generally)

� Quoted equity (not elected at FVTOCI)

� Government/corporate bonds not managed on a

contractual yield basis

� Unquoted equity previously held at cost� Most CDOs and other

asset-backed instruments (unless most senior in

waterfall)

Financial InstrumentsImpact on impairments

• Impact on impairment requirements:

Instrument IAS 39 classifications Impairment testing required?

New classifications Impairment testing required?

Equity investments

Available-for-saleCost less impairmentFVTPL

YesYesNo

FVTOCIFVTPL

NoNo

Debt instruments

Available-for-saleLoan and receivableHeld-to-maturityFVTPL

YesYesYesNo

Amortised costFVTPL

YesNo

Financial InstrumentsIAS 39 replacement project timeline

2013

Hedge accounting DerecognitionClassification and Measurement

Impairment

Q4 2009

H2 2010

H1 2010

Mandatory adoption effective date

Q1-3 2009 Exposure draft Exposure draftRequest for information

IFRS 9 – Financial assets

Exposure draft

Exposure draft

Finalised standard for early adopters

ED Financial Liabilities Re-exposure?

Final standard Impairment

Final standard Hedge Accounting

Final standard Derecognition

Final standard Financial Liabilities

Financial InstrumentsED Amortized cost and Impairment

ED Amortized cost and Impairment

• ED issued 5 November 2009– Comment deadline: 30 June 2010

• Objective: improve information on ‘effective return’ over expected life of a loan

• Introduces ‘expected loss’ model - removes ‘incurred loss’ model

• Only applies to amortised cost assets (e.g. loans & other debt instruments)

IFRS 1, First-time Adoption of International Financial Reporting Standards

IFRS 1: First-time adoption

IFRS 1 sets out transition guidance for adoption of IFRS

• Generally IFRS accounting policies at the first reporting date are retrospectively applied

– Exemptions and exceptions

• Opening balance sheet at beginning of comparative period

• Comparative financial statements and reconciliation to previous GAAP

• Transition rules apply to annual and interim financial statements

Example timeline: 2011 adopter

Jan 1, 2010 Dec 31, 2010 Dec 31, 2011

Restate previous GAAP to IFRS

First IFRSstatements

Current balance sheet date

IFRS opening balance sheet

Equity reconciliations

Profit reconciliation

Opening balance sheet – create at start of earliest period for which entity presents full comparative information under IFRS

Types of exemptions

Retrospective application prohibited

•Hedge accounting•Estimates

Elective exemptions include

•Deemed cost•Employee benefits•Cumulative translation differences•Decommissioning liabilities •Share-based payments

Two types of exemptions from “general rule” of retrospective application

Can pick and choose elective exemptions!

IAS 37, Provisions, Contingent Liabilities and Contingent Assets

IAS 37 (Provisions)

• IAS 37 addresses liabilities of uncertain timing or amount that are not within the scope of another standard.

• IASB aiming to replace IAS 37 with a new IFRS in 2010 (probably not effective before 2012)

– Closer alignment with US GAAP

– Closer alignment with other IFRSs

– More specific measurement requirements

Current IAS 37 requirements

Currently effective requirements

• Legal or constructive obligation

• Probable outflow that can be reliably estimated

• Measurement is at ‘best estimate’

• Discounting if effect is material

Proposed IAS 37 replacement

IASB proposals

• High level measurement objective – lower of:– Present value to fulfill obligation– Amount to be paid to cancel obligation– Amount to be paid to transfer obligation to 3rd party

• Expected present value measurement

• Inclusion of a risk adjustment

• Removal of “probable outflow” criterion

• Removal of reimbursement asset cap

• Insurance contracts excluded from scope

Documents

IFRS Update A discussion on the recent changes to IFRS and the road to convergence with US GAAP