acorn lecture-zwg-090428-2.ppt

International Financial Reporting Standards

The views expressed in this presentation are those of the presenters, not necessarily those of the IASB

Steps have been taken by accounting standard-

setters

2FSF recommendations

• Financial Stability Forum (FSF) tasked with managing the global regulatory response

• FSF report on April 2008 provides 67 recommendations, endorsed by G7

• Three of these recommendations related to financial reporting, forming the core of standard-setters’ response to credit crisis: Accelerate enhancements to accounting and disclosure of off-

balance sheet vehicles

Enhance guidance when applying fair value in illiquid markets

Strengthen disclosure standards

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1. Fair value measurement in illiquid markets

• Background– IASB formed an expert advisory panel in May 2008 in response to

the recommendations of the Financial Stability Forum.

– The panel comprised experts from preparers, auditors, users of financial statements, regulators and others.

– They met on seven occasions in June – October 2008.

– The panel identified practices used for measuring and disclosing financial instruments when markets are no longer active.

– September 30, 2008, the SEC Office of the Chief Accountant and FASB staff issued a press release clarifying their position on this.

– October 10, 2008, the FASB issued Staff Position (FSP) FAS 157-3, providing guidance on how to determine the fair value of a financial asset when the market for that asset is not active.

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• Background– October 2, 3 and 14, 2008, the IASB issued press releases stating

that it regards the SEC and FASB press release of 30 September and US GAAP guidance on fair value measurement (including SFAS 157 and FSP FAS 157-3) as consistent with IAS 39.

– The releases also state that the IASB and the FASB will continue to co-operate to ensure that the objective of fair value measurement is consistently applied in inactive markets, and to ensure comparability across borders.

– October 31, 2008, the IASB published the final report of the expert advisory panel and its staff summary setting out the context of the report.

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• Key points in the above SEC, FASB, and IASB documents

– When markets are dislocated, it is not appropriate to conclude that all market activity represents forced liquidations or distressed sales.

– The determination of whether a particular price is forced or not should be made at the transaction not the market level. Proper consideration should be given as to how recent the transaction occurred and the volume of the transaction relative to the market for the item.

– In determining fair value, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when observable inputs are not available. Regardless of the valuation technique used, an entity must include appropriate risk adjustments that market participants would make for credit and liquidity risks.

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• Key points in the above SEC, FASB, and IASB documents

– Broker (or pricing services) quotes may be an appropriate input when measuring fair value, but they are not necessarily determinative if an active market does not exist for the financial asset.

– The objective of disclosure is to help users of financial statements understand the techniques used and the judgments made in measuring fair value.

72. Re-classification out of fair value

• Background– European Banks experienced huge fair value losses as a result of crisis

– They detected different requirements in IFRS and US GAAP on reclassification out of fair value, and required to create a level playing field with their rivals using US GAAP

– Reclassification justified in view of change in market circumstances and management of instruments

– October 4-7: demanded by EU and ECOFIN

– October 9: IASCF Trustees supported accelerated steps by IASB

– October 13: IASB issued revisions to IAS 39 and IFRS 7 “Reclassification of financial Assets”

– October 16: Endorsed standards published in EU following positive advice by EFRAG.

82. Reclassification out of fair value

• The amendment: reclassification

– permits an entity to reclassify non-derivative financial assets out of

the fair value through profit or loss category in particular

circumstances.

– permits an entity to transfer from the available-for-sale category to the

loans and receivables category a financial asset that would have met

the definition of loans and receivables, if the entity has the intention

and ability to hold that financial asset for the foreseeable future.


• The amendment: appropriate disclosures are required when reclassification is made, to fully inform investors of effect.

– the amount reclassified into and out of each category;

– for each reporting period until de-recognition, the carrying amounts and fair values of all financial assets that have been reclassified in the current and previous reporting periods;

– if a financial asset was reclassified, the rare situation, and the facts and circumstances indicating that the situation was rare;

– for the reporting period when the financial asset was reclassified, the fair value gain or loss on the asset recognized in profit or loss or other comprehensive income in that and the previous reporting period;


• The amendment: appropriate disclosures are required when reclassification is made, to fully inform investors of effect.

– for each reporting period following the reclassification (including the reporting period in which the asset was reclassified) until de-recognition of the asset, the fair value gain or loss that would have been recognized in profit or loss or other comprehensive income if the asset had not been reclassified, and the gain, loss, income and expense recognized in profit or loss; and

– the effective interest rate and estimated amounts of cash flows the entity expects to recover, as at the date of reclassification of the asset.


• A specific regime for transition period – An entity shall apply those amendments from 1 July 2008.

– An entity shall not reclassify a financial asset before 1 July 2008.

– Any reclassification made in periods beginning on or after 1 November 2008 shall take effect only from the date when the reclassification is made.

– Any reclassification shall not be applied retrospectively to reporting periods ended before the effective date.

122. Reclassification out of fair value• The interesting result: Q3 profit and equity of 42 EU major

banks surveyed by JP Morgan– 18 out of 42 used the option in Q3. Most UK and German banks, some in

Italy and Scandinavia – French banks said they will consider it in Q4 – UBS said it will not.

– Assets worth €190bn reclassified out of FV-P/L or AFS (79% into L &R)

– Increased total pre-tax profit by €5.5bn and equity by €7.5bn

• Largest effect reported by (in €bn):

Asset transfer Equity impact % of profit%equity

Deutsche Bank 24,9 1,52 909% 4%

Commerz Bank 44,0 0,8 n/a 5%

Hypo Real Estate 3,5 1,8 n/a 93%

RBS 30,5 0,7 n/a 1%

Unicredito 18,1 0,9 77% 2%

HSBC 8,7 0,6 n/a 1%

DnB NOR 11 0,2 41% 2%


• Reaction from various directions– A level playing field between IFRS and US GAAP is important but

risks to drive the global financial reporting towards the lowest common denominator.

– accelerated efforts in complex areas could result in unhelpful reporting and unintended consequences.

– a comprehensive approach to improving the reporting for financial instruments should be developed by the boards as a matter of urgency.

– It is imperative to ensure independent standard setting process, and prevent any political pressure.

– the importance of ensuring sufficient due process before any changes are made by the IASB or the FASB.

– the importance of broad convergence between IFRSs and US GAAP.

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3. Additional disclosure: investments in debt instruments

• Requirement in IAS 39: impairment of debt instruments classified as available for sale (AFS) to be measured differently from that of loans and receivables (L&R) and held to maturity (HTM).

– AFS debt instruments: carried at fair value and impairment losses are measured as the difference between amortized cost and the lower fair value.

– L&R and HTM investments: carried at amortized cost and impairment losses are measured as the difference between amortized cost and the present value of estimated future cash flows, calculated using the original effective interest rate or—for variable interest rate instruments—the current effective interest rate (‘incurred loss model’).

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3. Additional disclosure: investments in debt instruments

• Call for change– In response to the global financial crisis the Board held three public

round-table meetings in November and December 2008 together with the FASB.

– Some participants suggested disaggregating the impairment losses recognized on AFS debt instruments.

– Most participants agreed that the following disaggregated information would be useful:

– the incurred loss portion—determined in the same way as for debt instruments measured at amortized cost using the incurred loss model; and

– the remainder of the fair value change.

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3. Additional disclosure:investments in debt instruments

• Call for change– They said the information would be useful because it improves their

transparency and permits comparison with the incurred losses recognized for L&R, and HTM debt instruments accounted for at amortized cost.

– However, they proposed different solutions for providing that disaggregated information.

– Preparers preferred recognizing only the incurred loss portion of the impairment loss in profit or loss and the remainder of the fair value change in other comprehensive income.

– Users advocated providing the disaggregation in notes or presenting separately the components of the impairment loss within profit or loss. They said that to do so

– provides more relevant information– historically has provided a better indication of ultimate realized losses, than

the incurred loss model, and – any other approach would damage their confidence in reported profit or

loss.

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• Proposed additional disclosure by the Board (091223)– An entity shall disclose the following for all investments in debt

instruments other than those classified as at fair value through profit or loss:

– Notes to P\L: pre-tax profit or loss as though the instruments had been:– classified as at fair value through profit or loss; and– accounted for at amortized cost.

– Notes to balance sheet: the following amounts in a way that permits comparison of:

– the carrying amount in balance sheet;– fair value; and– amortized cost.

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Notes to P\L:

Investments in debt instruments

20X1

Pre-tax P\L in each scenario

If all investments in debt instruments had been classified as financial assets at fair value through P\L

If all investments in debt instruments had been accounted for at amortized cost

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Notes to BS:

Investments in debt instruments (other than those classified as at fair value through P\L)

Type of investments

Dec. 31, 20X1

Carrying amount in BS

Fair value Amortized cost

L&R

HTM investments

AFS investments

Total

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• Proposed additional disclosure by the Board– An entity shall apply the requirement for annual periods ending on

or after 15 December 2008. However, comparative information relating to periods before the date of initial adoption is not required.

– While recognizing that the proposed disclosure would also be useful for investments in debt instruments classified as at fair value through profit or loss the Board decided not to require this information because entities are not required to maintain amortized cost-based information for those instruments.

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• Strong negative feedback: The IASB received 70 comment letters. Nearly all respondents disagreed with the proposed disclosures mainly because of the following reasons: the proposed timing is unrealistic;

the proposed pro-forma profit or loss information may be misleading and/or confusing, and will undermine the focus on the reported profit or loss;

the proposed disclosures are not focused on the suggestions made at the round-table meetings, and go significantly beyond those suggestions. In fact, the information suggested by many participants cannot be identified using the proposed disclosures.

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There was insufficient due process:– the comment period was inappropriately short– backdating the effective date so that it is earlier than the issue

date denies preparers – the required lead-time for implementation– for adoption because of the law in some jurisdictions (which

does not allow backdating).

The insufficient due process might have a detrimental effect on the high quality standard setting process, which could ultimately harm the reputation of IFRS;

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• Final Board Decision– In its Jan. 2009 meeting, the Board discussed responses to the

exposure draft, and decided – not to proceed with the proposed amendments at this time,– Will consider the issues addressed in the exposure draft and other

issues in its broader project on improving the accounting for financial

instruments.

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4. Improving Disclosures about FI (Amendments to IFRS 7)

• Background– IAS 30 Disclosures in the Financial Statements of Banks and Similar

Financial Institutions was issued by the IASC in August 1990.

– In April 2002, the restructured IASB resolved that all Standards and Interpretations issued under previous Constitutions continued to be applicable unless and until they were amended or withdrawn.

– In August 2005 the IASB issued IFRS 7 Financial Instruments: Disclosures, which replaced IAS 30, and was effective from Jan. 1, 2007.

– On 15 October 2008, IASB published for public comment an ED, Improving Disclosures about Financial Instruments (proposed amendment to IFRS 7).

– In March 2009, the IASB issued the final Amendments.

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• Reason for the amendments – The amendments were issued as part of the IASB’s response to the

global financial crisis.

– Users and others think that disclosures about fair value measurements, its methodologies and the related uncertainty should be enhanced, especially in the light of the present crisis.

– They also think disclosure requirements should be enhanced to better enable users to evaluate an entity’s exposure to liquidity risk arising from financial instruments and how the entity manages this risk.

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• Major requirements: Fair value

– to require a three-level fair value disclosure hierarchy in IFRS 7. – to use the same hierarchy as in SFAS 157 Fair Value Measurements

issued by FASB. – not to require disclosures about the fair value hierarchy for financial

instruments that are not measured at fair value. Existing disclosure requirements for those instruments would still apply.

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• Major requirements: Lliquidity– to emphasize the existing requirement to provide summary data about

each type of risk arising from financial instruments based on information provided internally to key management personnel.

– to require disclosure of separate maturity analyses for derivative and non-derivative financial liabilities.

– To retain the existing minimum contractual liquidity risk disclosures for non-derivative financial liabilities.

– not to require the existing minimum contractual liquidity risk disclosures

for some types of derivative financial liabilities.

• Major requirements: Transition– to require entities to apply the amendments for annual periods beginning

on or after 1 January 2009, with earlier application permitted and comparative disclosures not required on transition.

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28Summary of changes to IFRS 7

IFRS 7(applies > 1/01/07)

“Improving disclosuresabout FI”

Finalized in March 2009(applies> 1/7/09)

IFRS7 amendment“Reclassification of Financial Assets”

Issued on 13/10/08(applies>01/07/08“Investment in Debt

Instruments”ED 23/12/08

applies>15/12/08decided in 0901

not to finalize

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5. FASB proposals to improve guidance on fair value measurements and impairments

• Background– On March 12, 2009, members of the US

House Financial Service Committee met with the FASB Chairman to request the FASB to take further actions about determining the fair value and the impairments of securities investments.

– "Don't make us tell you what to do," said Rep. Randy Neugebauer (R-Tex.).

– "Just do it. Just get it done." Said Rep. Gary L. Ackerman (D-N.Y.): "If you don't act, we will."

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• Background– As a result of the meeting, the FASB published two proposed FASB

Staff Positions (FSP) on March 17, 2009: – FSP No. FAS 157-e Determining Whether a Market is Not Active and

a Transaction is Not Distressed. – FSP No. FAS 115-a, FAS 124-a, and EITF 99-20-b Recognition and

Presentation of Other-Than-Temporary Impairments (OTTI)

– After 15-day very short comment period ending on April 1, FASB vote on the new proposed guidance on April 2.

– The approved FSP formally promulgated on April 9.

– The new guidance was in effective in time for companies to use the guidance in their first quarter 2009 financial statements.

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• Summary of FSP FAS 157-4: Determining Fair Value When the Volume and Level of Activity for the Asset or Liability has Significantly Decreased and Identifying Transactions that are Not Orderly– The FSP provides a list of factors that an entity should evaluate to

determine whether there has been a significant decrease in the volume and level of activity for the asset or liability:– few recent transactions– price quotations not based on current information– price quotations vary substantially either over time or among market

makers– indexes are demonstrably uncorrelated with recent indications of

fair value for that asset or liability

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– significant increase in implied liquidity risk premiums, yields, or performance indicators for observed transactions or quoted prices compared with the reporting entity’s estimate of expected cash flows

– wide bid-ask spread or significant increase in the bid-ask spread– significant decline or absence of a market for new issuances (that is, a

primary market) for the asset or liability or similar assets or liabilities– little information is released publicly (for example, a principal-to-principal

market)

– When the entity concludes these, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value

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– Even if there has been a significant decrease in the volume and level of activity for the asset or liability, the FSP clarifies that it is not appropriate to conclude that all transactions for that asset or liability are not orderly.

– The entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The FSP provides a list of circumstances that may indicate that a transaction is not orderly.– there is not adequate exposure to the market for a period before the

measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions

– there was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant

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– the seller is in or near bankruptcy or receivership (that is, distressed), or the seller was required to sell to meet regulatory or legal requirements (that is, forced)

– the transaction price is an outlier when compared with other recent transactions for the same or similar asset or liability

– A reporting entity shall place less weight on transactions on which it does not have sufficient information to conclude whether the transaction is orderly.

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• Impairment of AFS and HFM financial assets– Current US GAAP requirements: SFAS No. 115 Accounting for

Certain Investments in Debt and Equity Securities requires the entire fair value change to be recognized in profit or loss once a fair value decrease is determined to represent OTTI. Factors considered OTTI include:

– the length of time and extent that the market value is below cost; – the financial condition and near-term prospects of the issuer; and – the intent and ability of the holder to retain the investment in the

security to allow for any anticipated recovery in fair value.

– Reversals of impairment losses through profit or loss are prohibited for both debt and equity securities.

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• Summary of FSP FAS 115-2, FAS 124-2 Recognition and Presentation of OTTI– Objective

– to make the OTTI guidance in US GAAP for debt securities more operational

– to improve the presentation and disclosures of OTTI on debt securities.

– Recognition– The FASB decided to replace the existing requirement that the

entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert that:

– the entity does not have the intent to sell the security; and– it is more likely than not the entity will not have to sell the security before

recovery of its amortised cost basis.

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– Recognition– The FSP incorporates examples of factors from existing literature on

OTTI assessment for debt securities and adds guidance on how those factors interact with the new assertions.

– If an entity does not expect to recover the entire amortised cost basis of the security, a debt security is considered OTTI.

– If management makes the new assertions for the remaining amortised cost basis (i.e. the previous amortised cost basis less any credit loss of the current period) the entity recognises only the ‘credit portion’ of the impairment in profit or loss and the reminder (non-credit losses) in other comprehensive income (OCI).

– Subsequent increases and decreases (if not an additional OTTI) in the fair value of available-for sale (AFS) debt securities will be included in OCI.

– For HTM debt securities non-credit losses are recognised in OCI and amortised over the debt security’s remaining life by offsetting the recorded value of the security (unless it is subsequently sold or there are additional credit losses).

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– Measurement– Credit losses are determined using an entity’s best estimate of the

present value of cash flows expected to be collected from the debt security.

– Presentation– An entity will be required to present the total OTTI amount in profit or

loss with an offset of the amount recognised in OCI. For example,

Total OTTI losses (10,000)

Portion of loss recognised in OCI (before taxes) 4,000

Net impairment losses recognised in earnings (6,000)– Amounts related to the non-credit portion of OTTI recognised in

accumulated OCI must be separately presented for AFS and HTM debt securities.

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– Disclosures– the cost basis of AFS and HTM debt securities by major security type;– the methodology and key inputs used to measure the portion of a

credit loss related OTTI by major security type– performance indicators of the underlying assets in the security– loan to collateral value ratios– third-party guarantees– levels of subordination– and vintage

– a roll forward of amounts recognised in profit or loss for which an OTTI has been recognised and the non-credit portion of the OTTI that has been recognised in OCI.

– Additional disclosures and all existing disclosures will be required for interim periods.

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• Reactions from various directions

– Edward Yingling, President of American Bankers Association, the key group driving the political pressure

– "Today's decision should improve information for investors by providing more accurate estimates of market values"

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• Reactions from various directions

– Arthur Levitt, former Chair of SEC, The Washington Post, 090326

– “Confidence, trust, and numbers that investors can believe in are the stuff that make or break the capital market. When investors question the validity of numbers, they sell and wait, rather than buy and invest.

– Yet those charged with building confidence and trust and presenting numbers that can be believed are under sustained attack, and they are losing.”

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• Reactions from various directions– David Weidner, Cheater, cheater; Commentary: Revising mark-to-

market rules would come back to haunt us, Market Watch | US, March 17, 2009,

– "Suspending or significantly altering fair value accounting would only serve to obscure current realities, further undermine investor confidence, and prolong the current crisis," said Cindy Fornelli, executive director of the Center for Audit Quality. "Investors need to know the current values of loans and securities in order to make rational investment decisions."

– they'd only get worse by letting banks decide how much their portfolios are worth. Japanese banks, after all, prolonged their recession in the 1990s by refusing to acknowledge that many of their real estate loans were essentially worthless.

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• Reactions from various directions– Matthew Philips, Mark-To-Market My Words, Newsweek | US,

090404– “Banks can now use ‘significant judgment’ to value assets. They can

stop assigning doomsday values to securities they think will have more value down the road…Investors fear the rule change will help banks disguise their garbage, which was part of what got us into this mess in the first place.

– It'll help big banks like Citi recoup billions in losses. But it does little to solve the underlying problem: piles of troubled assets no one wants. And it might not help for long, because Treasury Secretary Tim Geithner plans to rebuild a market for the assets by handing private investors cheap credit so they can start buying them up.”

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• Pressure on IASB: Bloomberg | International, 090404– EU ministers said in a statement today following a meeting of European

finance ministers and central bankers in Prague, it is “critical” that convergence on accounting standards is reached on the continent to ensure that the region’s banks are not placed at a disadvantage against U.S. competitors.

– “If it was up to me to decide, I would just download the U.S. text with Google and adopt it with a European blessing,” Italy’s Finance Minister told reporters after the meeting.

– German Finance Minister said he wants similar accounting principles in Europe as in the U.S.

– “We need to arrive at a level playing field on this matter,” French Finance Minister told reporters. “We need to stress to the IASB the urgency to examine accounting principles, in particular those concerning the valuation of illiquid assets.”

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• Response from IASB: On March 20, 2009, the IASB issue a request for views on FASB proposals, specifing:

– The IASB did not participate in the development of the proposed FSP and has not deliberated any of the FASB’s conclusions. The proposed FSP represent the views of the FASB only.

– Though the proposed FSP are a direct response to US-specific requests, the IASB believes that (in the light of its commitment to work jointly with the FASB to address issues arising from the financial crisis) it would be useful to seek the views of interested parties on the proposed FSP.

– This request for views is not an IASB due process document. Any action taken by the IASB will be subject to the IASB due process.

– The IASB would like to receive any views by April 20, 2009.

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• Response from IASB:On April 23, IASB decided– to include the FASB staff position on illiquid markets in its fair value

measurement ED to be issued shortly, but noted that it did not differ from IASB guidance.

– not to take up the FASB staff position on impairment, and consider it in its comprehensive project with FASB on simplification of accounting standards for FI.

476. Financial Crisis Advisory Group (FCAG)

• Purposes: by the end of last year, IASB and FASB established FCAG to advise the two boards about standard-setting implications of

– the global financial crisis and

– potential changes to the global regulatory environment.

486. Financial Crisis Advisory Group

• Members of the group: consists of 18 senior leaders with broad international experience with financial markets, joined by official observers representing key global banking, insurance, and securities regulators, co-chaired by

– Harvey J. Goldschmid, Former Commissioner, U.S. Securities and Exchange Commission

– Hans Hoogervorst, Chairman, AFM (the Netherlands Authority for the Financial Markets)

• The group also has official observers from– Basel Committee of Banking Supervisors– Committee of European Securities Regulators– Financial Stability Forum– International Association of Insurance Supervisors– Japan Financial Services Agency– US SEC


• Issues under review: – how improvements in financial reporting could help enhance

investor confidence in financial markets.

– significant accounting issues that require urgent and immediate attention of the boards, as well as issues for longer-term consideration.

– areas where financial reporting helped identify issues of concern, or may have created unnecessary concerns, during the credit crisis.

– areas where financial reporting standards could have provided more transparency to help either anticipate the crisis or respond to the crisis more quickly.

– Whether priorities for the IASB and the FASB should be reconsidered in light of the credit crisis.


– Potential areas that require future attention of the IASB and the FASB in order to avoid future market disruption.

– The implications of the credit crisis for the interaction between general purpose financial reporting requirements for capital markets and the regulatory reporting, particularly for financial institutions.

– The relationship between fair value and off-balance sheet accounting and the current crisis, both during and leading up to the crisis.

– The findings and relevance of conclusions of various studies underway, including the US SEC study under the Emergency Economic Stabilization Act of 2008.

– The need for due process for accounting standard-setters and its implications on resolving emergency issues on a timely and inclusive basis.

– The independence of accounting standard-setters and governmental actions to the global financial crisis.

acorn lecture-zwg-090428-2.ppt

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