1

Financial Instruments: Classification and

Measurement

Update

2

Scope of Classification and Measurement requirements

Exposure Draft proposal

The proposals apply to both financial assets and financial liabilities

Subsequent IASB tentative decisions

o Classification and Measurement requirements expected to be issued in November 2009 will only apply to financial assets

o The existing requirements of IAS 39 will continue to apply to financial liabilities in the short term

3

Classification criteriaExposure Draft proposal

The proposals introduce two classification criteria:(i) Basic loan features; and(ii) Managed on a contractual yield basis.Both criteria must be met in order to measure financial instruments at amortised cost

Subsequent IASB tentative decisions

o Both criteria must be considered in assessing the classification and measurement of financial assets

o Second criterion (which considers the entity’s business model) to be articulated more consistently with US FASB wording

o Entity’s business model must be considered firsto Could have more than one business model within

an entityo More application guidance on the criteria to be

included in Appendix B

4

The ‘other’ measurement attribute

Exposure Draft proposal

The proposals require that, where the two classification criteria are met, the ‘other’ measurement attribute is amortised cost, otherwise financial instruments are measured at fair value (FV)

Subsequent IASB tentative decisions

The ‘other’ measurement attribute for financial assets to be amortised cost where the classification criteria are met, otherwise financial assets to be measured at FV

5

Accounting for embedded derivatives

Exposure Draft proposal

The proposals eliminate the bifurcation rules for derivatives embedded within financial hosts, and instead require assessment of the classification and measurement of the hybrid contract in its entirety in accordance with the classification criteria

Subsequent IASB tentative decisions

Applicable to financial assets only

6

Fair Value Option

Exposure Draft proposal

The proposals retain a fair value option at inception, only where its application eliminates or significantly reduces an accounting mismatch

Subsequent IASB tentative decisions

Applicable to financial assets only

7

Cost exemption for unquoted equity instruments

Exposure Draft proposal

Remove the cost exemption for investments in unquoted equity instruments whose fair value cannot be reliably measured

Subsequent IASB tentative decisions

o Guidance to be developed on when cost is the best estimate of fair value, when no or very limited information is available on a timely basis

o Cost will never be the best estimate of fair value for quoted equity instruments

8

ReclassificationExposure Draft proposal

Reclassification is not permitted

Subsequent IASB tentative decisions

o Reclassification to be required when the entity’s business model changes (expected to be rare)

o Reclassification from a category other than FV to FVTPL required to be measured at FV on that day, with any differences from the carrying amount taken to a separate line item in profit or loss

o Reclassification from FVTPL to a category other than FVTPL will require the FV at that date to become its new carrying amount

9

Presentation option for equity instruments not held-for-trading

Exposure Draft proposal

o An entity can make an irrevocable election at initial recognition to present FV changes in OCI for investments in equity instruments not held for trading

o Dividends would also be recognised in OCIo No impairment or recycling of gains/losses on

derecognition of the asset

Subsequent IASB tentative decisions

o Retain irrevocable election to present FV changes from an equity investment in OCI where the instrument is not held for trading

o Dividends that are a ‘return of investment’ to be recognised in profit or loss

o No impairmento No recycling from OCI on disposal

10

Financial assets acquired at a discount

Exposure Draft proposal

Financial assets acquired at a discount that reflects incurred credit losses cannot be held with the objective of collecting cash flows

Subsequent IASB tentative decisions

Acquiring financial assets at a discount (that reflects incurred credit losses) does not of itself mean that instruments cannot have ‘basic loan features’ nor that they are not managed on a ‘contractual yield basis’. In principle, such instruments are assessed in accordance with the classification and measurement criteria and measured at amortised cost where both criteria are met.

11

Concentrations of credit riskExposure Draft proposal

The most senior tranche in a securitisation could be classified and measured at amortised cost, but lower level tranches that provide credit protection would be at FV

Subsequent IASB tentative decisions

o The issuer of a contractually linked instrument that affects concentrations of credit risk to measure the instrument based on an assessment of the classification criteria

o Holders of tranches to be required to use a 'look through' approach to assess the underlying assets generating cash flows. To qualify for measurement at amortised cost, the underlying pool must be instruments that meet the classification criteria

12

Timetable• Final requirements expected in

November to enable early adoption for financial years ending on or after31 December 2009

• Mandatory application date expected for periods beginning on or after 1 January 2013

• US FASB ED covering classification & measurement, impairment and hedging expected early 2010

13

ObservationsEmbedded derivatives – on early adopting• hybrids with financial asset hosts to be

required to apply the criteria to assess the classification and measurement of the hybrid in its entirety

• hybrids with financial liability and non-financial hosts to be required to apply existing IAS 39 requirements which will possibly result in ‘bifurcation’ of the hybrid

14

ObservationsFair Value Option – on early adopting• financial assets will only be able to be

designated at fair value where there is an accounting mismatch

• financial liabilities will be able to be designated at fair value in accordance with existing IAS 39 – that is, when

(a) there is an accounting mismatch;(b) the liability is managed or its

performance evaluated on a FV basis; or(c) there is an embedded derivative that

cannot be separately recognised and measured

15

ObservationsDividends on non-traded equity investments that are

a ‘return on investment’ are presented in profit or loss

• IAS 27 used to require different accounting treatment for pre- and post-acquisition dividends under the cost method for subsidiaries in separate financial statements

• the same issues that arose in distinguishing between pre- and post-acquisition dividends may arise in identifying ‘returns on’ versus ‘returns of’ investment in allocating dividends where the election to present FV changes in OCI is made

16

Financial Instruments: Classification and

Measurement

Update