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

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

2. 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.

3. 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

4. Convergence and Improvement 4 • 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.

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

6. Drivers for Timing of Convergence and Improvement Efforts 6 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

7. Drivers for Timing of Convergence and Improvement Efforts 7 • 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.

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

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

10. FASB/IASB ProjectTarget Dates

11. Current Status of Deliberations & Implications 11 • 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.

12. Current Status of Deliberations & Implications 12 • 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

13. Convergence: One Final Key Point 13 • 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??

14. MoU Projects

15. Financial Instruments 15 • 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

16. Financial Instruments 16 • 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

17. Financial Instruments 17 • 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

18. 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

19. Financial Instruments

20. 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

21. Fair Value Measurement 21 • 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)

22. 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

23. Consolidations 23 • Proposed Solution: • 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

24. Consolidations 24 • 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

25. Revenue Recognition • Problems: • 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

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

27. 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

28. Financial Statement Presentation 28 • 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

29. Financial Statement Presentation

30. Financial Statement Presentation 30 • 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

31. 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

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

33. Insurance 33 • Problems: • 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)

34. Insurance 34 • Companies Affected: • Insurance companies • 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

35. Leases 35 • Problems: • 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)

36. Leases 36 • Proposed Solution (cont’d): • 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)

37. Leases 37 • 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

38. 38 Conclusions

39. Conclusions 39 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

40. 40 Questions?