2011 october ifrs conference | financial instruments | c&m and impairment day-5 outline...

2011 October IFRS Conference | Financial Instruments | C&M and Impairment

Day-5 outline

• 08:30—Accounting for financial instruments in accordance

with IFRSs issued at 1 January 2012, but not the IFRSs

they will replace

• IFRS 9 Financial Instruments

• IAS 39 FI Recognition and Measurement

• 10:30—IASB’s project to replace IAS 39

• 11:30—Quiz/discussion/case

• 13:30—IFRS 7 FI Disclosures

• 14:30—IFRS 4 Insurance Contracts

• 16:00—Quiz/discussion/case

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© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

International Financial Reporting Standards

The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation.


Accounting for financial instruments—

IFRS 9 and IAS 39 at 1 January 2012

Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB

30 April to 4 May 2012


Introduction

• Replace IAS 39 Recognition and Measurement with IFRS 9 Financial Instruments in phases

• Phase I: Classification and measurement (completed)

• Phase II: Impairment (in progress)

• Phase III: Hedge accounting (in progress)

• Offsetting financial assets and financial liabilities (completed)

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IFRS 9Effective date and transition

• IFRS 9 effective 1 January 2015– early application permitted

• Restatement of comparative financial statements not required

– modified disclosures on transition

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IFRS 9Main changes from IAS 39

• Reduces complexity– only two classification categories– single impairment model (only FI’s at amortised cost)– embedded derivatives no longer separated from financial

asset host contracts

• Aligns measurement of financial assets with entity’s ‘business model’ and contractual cash flow characteristics of instruments

• ‘Own credit’ risk issue addressed • Elimination of ‘tainting rules’

– that caused bonds to be measured at fair value even if the business model was to hold

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Classification and measurementFinancial assets

Fair Value (No impairment)

Amortised cost(one impairment

method)Contractual cash flow

characteristics

Business model testFVO for

accounting mismatch (option)

All other Instruments:• Equities• Derivatives• Some hybrid contracts

Equities: OCI presentation

available(alternative)

Reclassification required when business model changes

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Business model: • objective of holding instruments is to collect contractual

cash flows rather than to sell prior to contractual maturity to realise fair value changes

• not an instrument by instrument approach to classification• assess contractual terms of instruments within such a

business model

7Financial AssetsAt amortised cost



Contractual cash flow characteristics• Payments represent solely principal and interest• Interest is consideration for time value of money and

credit risk• Prepayment/extension options may qualify

No ‘tainting’ rules for assets at amortised cost• gains or losses from derecognising such items to be

presented separately with additional disclosures

8Financial AssetsAt amortised cost continued



Alternative presentation of fair value changes in other comprehensive income (OCI)

Scope • investments in equity instruments not held for trading

Features• alternative available instrument by instrument

• dividends recognised in P&L

• no recycling, impairment or change in presentation

9Financial AssetsEquity investments: OCI alternative



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Hybrid contracts

Financial host Non-financial host

IAS 39 guidance retained

No separation –part of

classification

Financial AssetsEmbedded derivatives



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Fair value option available, if…

Accounting mismatch

Managed on fair value basis

Embedded derivative(s)

Not managed to collect contractual cash flows = FV

Hybrid contracts with financial host

classified in entirety

*Circumstances when FVO available is unchanged for financial liabilities

Financial AssetsFair Value Option (FVO)



Unquoted equities and their derivatives• Fair value measurement required• Cost may be an appropriate estimate of fair value

– if more recent information not available or a wide range of outcomes

• Does not apply to equities held by financial institutions and investment funds

Contractually linked and non-recourse instruments• Detailed application guidance• ‘Look through’ approach

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Financial AssetsApplication guidance



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IAS 39 IFRS 9

Classification Many categories each with different measurement methods

Two measurement bases: Amortised cost and Fair Value

Measurement Irrevocable option at initial recognition to present fair value changes of some equity investments in OCI

Impairment Different impairment rules depending on category and instrument type

Only debt instruments at amortised cost are tested for impairment

Financial AssetsSummary of Key Changes



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Financial AssetsSummary of Key Changes continued

IAS 39 IFRS 9

Tainting Tainting rules for held to maturity investments

No tainting rules

Reclass-ification

Some reclassifications permitted/required

Reclassifications required if and only if business model changes

Embedded derivatives

Bifurcation of embedded derivatives required in some cases

No separation, same classification approach (for hybrid financial assets with financial hosts)

FVO Available if specific criteria are met

Available if eliminating or significantly reducing an accounting mismatch



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Example 1:Equity investment

Held for tradingFair value - with changes

recognised in profit or loss

Not held for trading

Fair value – irrevocable choice of recognising

changes in profit or loss or OCI



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Example 2:Debt investment (basic loan features)

Held to collect contractual cash flows

Amortised cost(FVO available if criteria are

met)

Not held to collect contractual cash flows

Fair value through profit or loss



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Example 3:Debt investment (embedded derivative)

Hybrid contract (as a whole) has basic loan features and is Held to collect contractual CFs

Whole instrument at amortised cost

All other hybrid contracts with financial hosts

Whole instrument at fair value through profit or

loss



Classification and measurementFinancial liabilities

All financial liabilities

Amortised cost

FVO for mismatch, managed

on FV basis and hybridsExcept:

Held for tradingFair value through

P&L

Own credit in

OCI

• Hybrid financial liabilities are bifurcated• No reclassification permitted

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Financial LiabilitiesFVO and own credit

• What is ‘own credit’?– fair value changes in liability arising from changes in the

issuer’s credit quality• How is it measured?

– often measured as change in margin over a benchmark interest rate

• What is the concern?– Gain when credit quality deteriorates, loss when credit

quality improves– Reporting such gains and losses is not useful

– Board’s Request for Information on measurement of liabilities

– ED on classification and measurement



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To address ‘own credit risk’• Retain IAS 39 measurement requirements for financial

liabilities:– held for trading fair value through P&L– hybrid liabilities bifurcation requirements in IAS 39– ‘vanilla’ liabilities amortised cost– maintain FVO (with current eligibility conditions)

BUT• Separate out ‘own credit risk’ for FVO• ‘Own credit risk’ portion would be separated in a

manner similar to that previously used in IFRS 7 for disclosure (IFRS 7 B4)

Financial LiabilitiesFVO and own credit continued



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Financial LiabilitiesFVO and own credit continued

Change in FV

attributable to all

factors except ‘own credit risk’

Change in FV

attributable to ‘own credit’

(not recycled)

Profit or Loss

Profit XXX

Financial liability at FVOon statement of financial position at (full) fair value

Mandatory for all liabilities at FVO unless this would create or enlarge an accounting mismatch

Statement of Comprehensive Income

Other Comprehensive Income

XXX



Impairment

IAS 39 requirements:• Incurred loss approach for financial assets • Impairment loss only recognised when:

– trigger (loss) event occurs– impact can be reliably estimated

• More than one model depending on classification

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2323Impairment continued

Criticisms of the incurred loss approach:• Expected losses not recognised before trigger events

– overstates/front-loads interest revenue – results in ‘too little, too late’ recognition of loan losses– triggers inconsistently applied

• Does not reflect the underlying economics of the transaction

• Need to improve usefulness of financial statements and timing of recognition of losses

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© 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | www.ifrs.org

24Hedging

• ‘Hedging’ and ‘hedge accounting’ are two different things

• What is hedging?– managing risks by using one financial instrument

(‘hedging instrument’) purposely to offset the variability in FV or cash flows of a recognised asset or liability, firm commitment, or future cash flows (‘hedged item’)



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Example:Hedging

• On 1/12/X1 a jeweler purchased 1,000 ounces of gold for $1,500 per ounce to manufacture jewelry whose selling price fluctuates with changes in the gold price

• Jeweler is concerned the gold price will decline.– buys an option (settled net in cash) to sell 1,000 ounces of

gold at $1,500 anytime in the next two months. The option is measured at FVTPL.

– at 31/12/X1 gold price is $1,400– the $100,000 gain on the option is recognised in profit or

loss in 20X1– but the ‘loss’ attributable to the reduced selling price will affect profit or loss in the future (ie when the sale is recognised).

• Accounting ‘mismatch’© IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org


26What is hedge accounting?

• Matching the change in FV of the hedging instrument and the hedged item in profit or loss for the same period

• Hedge accounting is only an issue when normal accounting would put the two fair value changes in different periods—sometimes referred to as an ‘accounting mismatch’


• Hedge accounting recognises the offsetting effects of changes in the fair values or the cash flows of the hedging instrument and the hedged item.

• Strict conditions must be met before hedge accounting is possible:

– there must be formal designation and documentation of a hedge, including the risk management strategy for the hedge.

– the hedging instrument must be expected to be highly effective in achieving offsetting changes in fair value or cash flows of the hedged item that are attributable to the hedged risk.

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Hedge accountingIAS 39 requirements


• Hedge exposure to fair value changes of recognised asset or liability or unrecognised firm commitment (or portion of these attributable to a particular risk)

• Hedge of the foreign currency risk of a firm commitment

• Recognition of gains and losses on hedged item and hedging instrument in profit and loss and adjust the carrying amount of the hedged item (if not measured at cost)

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Types of hedge accountingFair value hedge accounting



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Example:Fair value hedge accounting

• Entity borrows 1,000, 3 years, 5% fixed rate, payable at the end, measured at amortised cost

• Hedged with a derivative whose value is linked to an interest rate index

• End of year 1, market rate = 6%. FV of 50 payable in 1 year at 6% + 1,050 payable 2 years at 6% = 50 x .943396 + 1,050 x .889996 = 982, but this 18 ‘gain’ is not recognised

• Value of the derivative declines to -20

• Note: there is small ineffectiveness = 2



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Financial position when loan made:

Cash 1,000

Loan payable 1,000

Adjust loan end of year 1 to reflect rate change:

Loan payable (hedge acct) 18

P&L (18 gain – 20 loss) 2

Derivative (Liability) 20

Financial position end of year 1:

Cash 1,000

Derivative (Liability) 20

Loan payable 982

Equity 2

Example:Fair value hedge accounting continued



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• Hedge of the exposure to variability in cash flows attributable to a particular risk associated with

• a recognised asset or liability or • a highly probable forecast transaction

• Hedge of the foreign currency risk of a firm commitment• Portion of hedge deemed to be effective:

• gains and losses recognised in OCI

• Portion of hedge deemed to be ineffective:• gains and losses recognised in profit or loss

• Treatment of cumulative gains or losses differs based on what ‘type’ of asset or liability is subsequently recognised

Types of hedge accountingCash flow hedge accounting



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• Entity sells goods for 1,000 floating rate 3-year note receivable

• Interest rate risk managed with a derivative (interest rate swap)

• End of year 1 interest rates increase – PV of cumulative cash flows increase by 100

• But FV of swap decreases by 105• Note: Some hedge ineffectiveness

Example:Cash flow hedge accounting



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Opening financial position:Receivable 1,000

Equity 1,000Ineffective portion of hedge:

P&L 5 (ineffective portion of hedge)

OCI (Equity) 100Derivative (Liability) 105

Closing financial position:Receivable 1,000Equity (OCI) 100 (effective portion of hedge)

Derivative (Liability) 105Equity 995

example continued next slide...

Example:Cash flow hedge accounting continued


• Hedge of a net investment in a foreign operation

– as defined in IAS 21

– accounted for similarly to cash flow hedges

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Types of hedge accountingNet investment in foreign operation



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• Entity A has a wholly-owned subsidiary, Entity B. Entity has a CU functional currency and Entity B has a FCU functional currency. Entity A paid FCU100,000 for the investment in net assets at fair value of FCU80,000. Goodwill of FCU20,000 was recognised.

• At acquisition, Entity A loaned Entity CU15,000 (exchange rate was FCU2:CU1). Settlement is not planned or expected in the near future.

Example:Net Investment in foreign operation



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• At acquisition, Entity A designates the net investment in Entity B as a hedged item in its consolidated financial statements.

• The maximum amount that can be designated is FCU130,000

• Net assets at FV: FCU80,000

• Goodwill: FCU20,000

• Loan: FCU30,000

• If the loan was expected to be settled in the foreseeable future, it would not form part of the net investment.

Example:Net Investment in foreign operation continued



Questions or comments?

Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation.

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The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January 2012 but not the IFRSs they will replace.

The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise.

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2011 october ifrs conference | financial instruments | c&m and impairment day-5 outline...

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