Convergence, and Change IFRS, Convergence, and Change Richard Dinkel Controller, Koch Industries, Inc. Member of FASAC

Disclaimer The views expressed in this presentation are my own and do not represent positions of the Financial Accounting Standards Advisory Council or the Financial Accounting Standards Board. Positions of the FASB are arrived at only after extensive due process and deliberation.

IFRS Timeline 2007- SEC eliminates US GAAP reconciliation for IFRS filers 2007- SEC concept release on use of IFRS for US registrants 2008- SEC issues proposed “Roadmap” for adoption of IFRS in the US 2010- SEC issues statement of continued support for convergence between US GAAP and IFRS

Convergence and Improvement FASB and IASB working since 2002 to improve and converge U.S. GAAP and IFRS. Memorandum of Understanding (MoU) Identified 9 major accounting areas needing improvement in both U.S. GAAP and IFRS Completed Business Combinations project in 2007 by issuing FAS 141(R) and 160, and IFRS 3 Remainder of projects still ongoing (slide 8) In addition, just beginning joint deliberations on De-recognition Project. 4

Overall Goal of Convergence Improved, high-quality, converged standards developed through rigorous due process Priorities: Independence Improvement Convergence 5

Drivers for Timing of Convergence and Improvement Efforts Financial Crisis underscored importance of global convergence of standards G-20 has called for FASB/ IASB to “redouble their efforts” to complete their MoU projects by June 2011 SEC awaiting outcome of MoU projects before making decision about IFRS for U.S. public companies 6

Drivers for Timing of Convergence and Improvement Efforts The June 2011 date also is being driven by the IASB because of: Countries, including Brazil, Canada, India, and Korea, that have announced plans or intentions to adopt IFRS for their listed companies on or around 2011 or 2012 Terms ending for IASB chair Sir David Tweedie and two other IASB board members in mid-2011. 7

Current Status of Deliberations & Implications Five major projects generally on track toward convergence: Fair Value Measurement Consolidations Revenue Recognition Financial Statement Presentation Financial Instruments with Characteristics of Equity 8

Current Status of Deliberations & Implications Three major projects not on track toward convergence: Financial Instruments Insurance Leases Further deliberations required Target timelines for final standards could be in jeopardy 9

FASB/IASB Project Target Dates Exposure Draft Final Statement Financial Instruments May 2010 March 2011 Fair Value Measurement October 2010 Consolidations January 2011 Revenue Recognition June 2011 Financial Statement Presentation Financial Instruments with Characteristics of Equity June 2010 Insurance Leases

Current Status of Deliberations & Implications This intense level of standard setting is unprecedented FASB has issued, at most, 4 major standards in one year In addition, FASB has issued at one time no more than 3 exposure documents proposing significant changes IASB has issued 9 major standards in its 9-year history. 11

Current Status of Deliberations & Implications Volume and timing of MOU projects Challenges ability of constituents to provide quality input to due process Reactions from CFA Institute, FEI, ITAC and others: improvement is primary, speed is secondary. Challenges preparers’ ability to implement final standards and users’ ability to analyze new financial reports Joint Invitation to Comment to be issued by both Boards to seek input from constituents regarding effective dates and transition approaches 12

Convergence: One Final Key Point If FASB/IASB achieve convergence on all of these major projects U.S. GAAP and IFRS will not be completely converged. Point raised in February 2010 SEC statement Full IFRS adoption may still not happen More urgent priorities Costs of full adoption are high Mixed support from regulators Unresolved reporting issues Convergence conflicts Private company standards How to stay converged?? 13

MoU Projects

Financial Instruments Problems: Complexities and inconsistencies within and between U.S. GAAP and IFRS, on: Classification and measurement, Impairment Hedge accounting In U.S., different impairment approaches for debt securities and loans especially problematic Financial Crisis pointed to untimely recognition of credit impairment of loans held for collection by financial institutions 15

Financial Instruments Proposed Solution: Fewer/ simpler classification and measurement approaches Two “buckets”: FV (mandatory for derivatives and trading instruments; default for other items) and FV/OCI (optional, based on business model, for other assets and liabilities, such as many loans and core deposits) Fair value information on the balance sheet for most financial instruments Exceptions: short-term trade receivables and payables; in certain circumstances, own debt Amortized cost information also reported for FV/OCI items 16

Financial Instruments Proposed Solution (cont’d): Income statement puts non-credit-related FV changes of FV/OCI assets in OCI, rather than Net Income Consistent with approach taken in FSP FAS 115-2 and 124-2 Improvements to impairment accounting, to develop single overall approach applicable to debt securities as well as loans Simplified criterion to qualify for hedge accounting, leading to more consistent and transparent application 17

Financial Instruments Companies Affected: All; greater effect on financial institutions Challenges to Convergence: IASB currently has reached different conclusions in their proposed model, highlighted in table on following slide. We may or may not be able to reconcile these differences While many users in the U.S. favor the more prominent display of FV information on the balance sheet, for loans, deposits, etc., banks and bank regulators generally oppose such change

Financial Instruments Area FASB IASB Main Classification Categories Fair value through net income Fair value through other comprehensive income (FV- OCI) Amortized cost Credit Impairment Based on past events and existing conditions and their implications for the collectibility of the financial asset(s) Recognized in net income Impairment recognized based on expected credit losses over the life of the financial asset Hedge Accounting Bifurcation by risk allowed for financial items Qualitative assessments required at inception (quantitative may be necessary) Reasonably effective threshold Currently deliberating issues with a plan to issue and exposure draft in the second half of 2010

Fair Value Measurement Problem: US GAAP and IFRS not yet converged; FASB took the lead on improving this area a few years ago with Statement 157 Statement 157: how to, not when to, measure fair value The IASB exposed Statement 157 with some fairly minor suggested modifications Both FASB and IASB have since issued additional guidance in this area in response to Financial Crisis Proposed Solution: One global definition of fair value and approach to measurement and disclosure of fair value

Fair Value Measurement Companies Affected: All, with greater effect on financial institutions; overall, will cause relatively insignificant changes when compared to current U.S. GAAP Challenges to Convergence: No significant differences regarding how to measure fair value More significant differences relate to when to use fair value (see Financial Instruments Project) 21

Consolidations Problems: Inconsistent guidance between U.S. GAAP and IFRS, especially on consolidation of variable interests (securitizations/ structured entities) Consolidation requirements for voting interests may lead to non-economically-representative consolidation decisions, in certain situations: Effective control rather than contractual control Options, convertible instruments, agency relationships

Consolidations Proposed Solution: Companies Affected: Overall consolidation standard for both variable interest and voting interest entities identifying the party, if any, with power over and benefits from the key economic activities of the entity Will result in fewer activities off-balance sheet FASB already tightened de-recognition and consolidation guidance for variable interests (VIEs), through FAS 166 and 167, bringing it closer to IFRS and setting stage for convergence Companies Affected: All 23

Consolidations Challenges to Convergence: Potential differences between Boards about how to evaluate effective control of voting interest entities (IASB: ability to control concept vs. FASB: ability to control with historical evidence view) Banks fought recent changes to U.S. GAAP (SFAS 166 and 167), but bank regulators eased transition by phasing-in recognition for regulatory capital purposes 24

Revenue Recognition Problems: Proposed Solution: U.S. GAAP: in 200+ standards (now codified), inconsistent, developed piecemeal IFRS: very limited guidance, permitting “anything goes application” or need look to U.S. GAAP to apply IFRS Proposed Solution: Common principle, based on satisfaction of performance obligations, that can be applied consistently across various industries and transactions and better reflect the underlying economics of revenue transactions

Revenue Recognition Companies Affected: Challenges to Convergence: All, but greatest effect on software and construction companies Challenges to Convergence: Nothing significant between the Boards 26

Financial Statement Presentation Problem: The ability of users to predict cash flows associated with a company would be enhanced greatly if the basic financial statements (balance sheet, income statement, cash flow statement) related to each other more cohesively and presented more disaggregated information Proposed Solution: A consistent format across statements, classifying items into business and financing categories, with a further disaggregation of business into operating and investing activities

Financial Statement Presentation Proposed Solution (cont’d): Required use of the direct method for presentation of operating cash flows Disaggregation of reported items by function and nature to facilitate prediction of cash flows Together all of these changes should help improve communication between preparers and users 28

Financial Statement Presentation Statement of financial position Statement of comprehensive income Statement of cash flows DIRECT Business Operating assets and liabilities Investing assets and liabilities Operating income and expenses Investing income and expenses Operating cash flows Investing cash flows Financing Financing assets Financing liabilities Financing asset income Financing liability expenses Financing asset cash flows Financing liability cash flows

Financial Statement Presentation Companies Affected: All business entities (not-for-profit entities have been scoped out) Challenges to Convergence: Differences in approaches by Boards for disaggregating expenses by nature FASB: in segment note IASB: at consolidated level in notes, pending post-implementation review of IFRS 8 Preparers have expressed concerns about implementation costs, especially about direct method for presenting operating cash flows 30

Financial Instruments with Characteristics of Equity Problem: Inconsistent classification and measurement of hybrid financial liabilities with similar characteristics; vast rules-based literature (especially in U.S.) leading to structuring opportunities Proposed Solution: Replace complex inconsistent literature with one set of coherent classification requirements that define equity based on two principles Ownership of the entity Settlement with a specified number of ownership instruments

Financial Instruments with Characteristics of Equity Companies Affected: All companies Challenges to Convergence: Nothing significant between the Boards 32

Insurance Problems: Proposed Solution: Lack of a standard in IFRS for insurance contracts U.S. guidance is unique and industry-specific Industry practice of excessive deferrals of contract acquisition costs Proposed Solution: Common, high-quality standard for recognition, measurement, presentation, and disclosure of insurance contracts, with contract acquisition costs expensed when occurred (similar to what is done for regulatory purposes) 33

Insurance Companies Affected: Challenges to Convergence: The Boards have tentatively reached different conclusions on numerous fundamental issues Definition of insurance, measurement of liability, unbundling of contracts, accounting for acquisition costs and participating contracts U.S. insurance industry generally has different views about the model than other major global insurers 34

Leases Problems: Proposed Solution: Off-balance sheet presentation of leased assets and related financing A bright-line distinction, especially in U.S. GAAP, between on- and off-balance sheet transactions, leading to structuring opportunities Proposed Solution: For lessees, lease obligations recognized on balance sheet as liabilities, along with a corresponding asset (using a “right to use” approach) 35

Leases Proposed Solution (cont’d): Companies Affected: Also looking at lessor accounting, to achieve consistency with model in Revenue Recognition Project Companies Affected: All; key industries affected include retailers, banks (branch offices), big equipment lessees (such as airlines and hospitals) 36

Leases Challenges to Convergence: Differences between the Boards on approach to lessor accounting: FASB: performance obligation approach, which recognizes revenue over lease term. IASB: de-recognition approach that results in more up-front revenue Leasing industry opposed to pattern of income recognition in lessee model and to performance obligation approach to lessor revenue recognition 37

Conclusions 38

Conclusions Proposed changes are unprecedented Politics may be impactful Uncertainty still abound FASB objectives are independence, improvement, and convergence—in that order Thus, due process is crucial Not too early to start planning 39

Questions? 40