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IFRS NEWSLETTERFINANCIAL INSTRUMENTS

Issue 8, December 2012

We welcome the plan for the IASB to discuss stakeholder feedback on the general hedging review draft before issuing a final standard. 

Andrew Vials,KPMG’s global IFRS Financial Instruments leaderKPMG International Standards Group The future of IFRS financial

instruments accountingThis edition of IFRS Newsletter: Financial Instruments highlights

the discussions and tentative decisions of the IASB in December 2012 on the financial instruments (IAS 39 replacement) project.

Highlights

Impairment

l    Re-exposure is expected in the first quarter of 2013, with a 120-day comment period.

Hedge accounting

General hedging

l    The IASB will discuss feedback received on the general hedging review draft in January 2013.

l    A final general hedging standard is now expected later in the first quarter of 2013.

Macro hedging

l    The portfolio revaluation approach for macro hedging activities may be extended to commodity price risk and foreign exchange risk.

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IMPAIRMENT REDELIBERATIONS REACH A CONCLUSION

The story so far ...Since November 2008, the IASB has been working to replace its financial instruments standard (IAS 39 Financial Instruments: Recognition and Measurement) with an improved and simplified standard. The IASB structured its project in three phases:

Phase 1: Classification and measurement of financial assets and financial liabilities

Phase 2: Impairment methodology

Phase 3: Hedge accounting.

In December 2008, the FASB added a similar project to its agenda; however, the FASB has not followed the same phased approach as the IASB.

The IASB issued IFRS 9 Financial Instruments (2009) and IFRS 9 (2010), which contain the requirements for the classification and measurement of financial assets and financial liabilities. Those standards have an effective date of 1 January 2015. In November 2012, the IASB issued an exposure draft on limited amendments to the classification and measurement requirements of IFRS 9.

The Boards were working jointly on a model for the impairment of financial assets based on expected credit losses, which would replace the current incurred loss model in IAS 39. The Boards previously published their own differing proposals in November 2009 (the IASB) and in May 2010 (the FASB), and published a joint supplementary document on recognising impairment in open portfolios in January 2011. However, at the July 2012 joint meeting the FASB expressed concern about the direction of the joint project and began developing its own impairment model, the current expected credit loss (CECL) model. Meanwhile, the IASB has continued to develop separately its three-bucket impairment model.

The IASB has split the hedge accounting phase into two parts: general hedging and macro hedging. It issued a review draft of a general hedging standard in September 2012, and is working towards issuing a discussion paper on macro hedging in the first half of 2013.

What happened in December?In December 2012, the IASB concluded redeliberations on its three-bucket impairment model, and plans to issue an exposure draft in the first quarter of 2013, with a 120-day comment period. By contrast, the FASB plans to issue an exposure draft of its CECL model later in December. Although the comment periods will not align exactly, we anticipate that many constituents will wish to analyse and compare both proposals before providing comments. The feedback received by the Boards is likely to be critical in determining the direction of these projects in 2013.

Since the general hedging review draft was posted on the IASB’s website, several constituents have asked the IASB to address specific issues with the draft before it is finalised. In an encouraging development, the staff announced in December that the IASB would discuss some of those issues at its January 2013 board meeting before proceeding to finalise the draft. We support the IASB’s willingness to use the review draft process to identify potential practice issues before finalising such a significant standard.

The IASB also continued its discussions on the macro hedging project. It will continue to explore the possibility of opening the revaluation approach to include commodity price risk and foreign exchange risk in its discussion paper. This discussion paper is currently scheduled for the first half of 2013.

Contents

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IMPAIRMENT

The IASB will publish a revised exposure draft in the first quarter of 2013.

What happened in December?After finalising its technical redeliberations last month, the IASB discussed the following items at the December 2012 meeting.

• Sweep issue with respect to transition requirements

• Compliance with due process requirements

• Considerations for re-exposure

• Next steps – the comment period and permission to ballot.

The transition requirement has been updated for assets without initial credit quality information.

Transition requirements – sweep issue

What’s the issue?

The purpose of the discussion was to align the transition requirements with the modified criteria for recognising lifetime expected losses.

Before its redeliberations in November 2012, the IASB’s three-bucket impairment model had previously included two criteria for recognising lifetime expected losses – i.e. that the probability of not collecting all contractual cash flows:

• has increased more than significantly since initial recognition (the deterioration criterion); and

• is at least reasonably possible (the credit quality criterion).

An entity might find retrospective application of the deterioration criterion on initial adoption of a new impairment standard to be impracticable without the use of hindsight. This is because the entity would have to establish what its assessment of the probability of collecting all contractual cash flows was, or would have been, at initial recognition. This may have occurred a long time previously, and the relevant initial credit quality information may not be available.

To address this problem – and based on its previous criteria for the recognition of lifetime expected losses – in July 2012, the IASB had tentatively decided that, if an entity does not use the initial credit quality information for existing financial assets when initially applying the new impairment model, then it would evaluate those assets using only the credit quality criterion for the recognition of lifetime expected losses.

In November 2012, the IASB tentatively decided to simplify the lifetime loss criteria to contain a single test – that an entity would recognise lifetime expected losses if there has been a significant deterioration in credit quality since initial recognition. Although not retaining a separate credit quality criterion, the IASB did tentatively decide that lifetime expected losses for a higher credit quality asset would be recognised when the asset deteriorates below ‘investment grade’.

What did the staff recommend?

To ensure consistency with the modified lifetime expected loss criteria, the IASB staff proposed the following adjustment to the transition requirement.

“If the credit quality at initial recognition is not used at the date of initial application, the transition provisions should require these financial assets to be evaluated only on the basis of whether the credit quality is below ‘investment grade’ at the date of initial application.” [our emphasis added]

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What did the IASB discuss?

One IASB member noted that in November 2012, the Board also decided that an entity may use delinquency information to assess the criteria for recognising lifetime expected losses. For example, delinquency may be the only borrower-specific information available without undue cost or effort to assess credit deterioration for some retail portfolios. Therefore, in this case an entity would use delinquency information on transition.

What did the IASB decide?

The IASB agreed with the staff recommendation.

Due process requirements have been met.

Due process considerations

What’s the issue?

In November 2012, the IASB finalised its technical redeliberations on the current impairment proposal.

What did the staff recommend?

During the December meeting, the IASB staff presented an analysis showing that the IASB had complied with its formal due process procedures in developing the new impairment model, and that it is ready to start the balloting process for approval of a re-exposure draft.

What did the IASB decide?

The IASB agreed with the staff analysis.

Re-exposure is expected in the first quarter of 2013, with a 120-day comment period.

Re-exposure, comment period and permission to draft

What’s the issue?

Since the publication of the exposure draft Financial Instruments: Amortised Cost and Impairment in November 2009 and the supplementary document in January 2011, the IASB has redeliberated the issues and feedback received, and has developed a new three-bucket impairment model. Even though all of the models that have been proposed are expected loss models, the three-bucket model differs significantly from the models previously exposed and so may warrant re-exposure.

What did the staff recommend?

The staff made recommendations to:

• publish a re-exposure draft of the impairment model;

• adopt a 120-day comment period for the re-exposure draft; and

• begin the balloting process.

In addition, the staff recommended undertaking some fieldwork in conjunction with the exposure process by working closely with a small number of institutions in different jurisdictions. The objective of the fieldwork would be:

• to assess and illustrate how faithfully the three-bucket model represents expected credit losses in different scenarios; and

© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 5

• to solicit views on the cost and operability of the proposals.

The staff asked the IASB members whether any intend to dissent from the proposals.

What did the IASB decide?

The IASB agreed with the staff recommendations.

One IASB member indicated that he may dissent from the proposals, but had not yet decided. His main concern was that:

• the proposed model would require an entity to recognise an allowance for 12 months’ expected losses on initial recognition of a financial asset; and

• this would, in effect, require entities to book a day one loss on origination of a loan.

Next steps – comment letter and balloting

FASB’s next steps

The FASB is expected to issue an exposure draft on its CECL model later this month, with a comment period of 30 April 2013 (or 120 days). The FASB will invite comments both on its own CECL model and on differences between the CECL model and the IASB’s three-bucket model.

IASB’s next steps

The staff will now begin the balloting process. An IASB re-exposure draft is expected in the first quarter of 2013. The staff noted that it may be issued in February 2013.

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HEDGE ACCOUNTING

The IASB will discuss feedback received on its general hedging review draft in January 2013. A final general hedging standard is now expected later in Q1 2013.

General hedgingIn September 2012, the IASB issued a draft of its forthcoming IFRS on general hedge accounting (the ‘review draft’), which proposes to align hedge accounting more closely with risk management. Originally, the IASB had planned to finalise the standard in December 2012, but the work plan was recently updated to reflect a planned Q1 2013 release.

In December, the staff announced that, at its January 2013 board meeting, the IASB would discuss some stakeholder comments on the review draft before proceeding to finalise the draft. These issues include:

• paragraph B6.5.5 of the review draft on applying the ‘hypothetical derivative’ method for assessing hedging effectiveness; and

• the interaction between the new general hedging model and the macro hedging guidance in IAS 39.

For more information on those two issues, please see KPMG’s letter to the IASB on the review draft.

The portfolio revaluation approach for macro hedging activities may be extended to commodity price risk and foreign exchange risk.

Macro hedging

What happened in December?

In December, the IASB continued its series of educational meetings on the macro hedging project. It discussed how the portfolio revaluation approach might be applied:

• to accounting for macro hedging activities for risks other than interest rate risk; and

• to address the needs of entities other than financial institutions.

Under the revaluation approach for macro hedges, entities would calculate a revaluation adjustment for the hedged risk for items whose hedged risk is managed on an open portfolio basis.

The IASB discussed two risks that some companies manage dynamically on an open portfolio basis:

• commodity price risk; and

• foreign exchange risk.

The IASB was not asked to make any decisions at this meeting.

Commodity price risk

The staff described how some companies use risk management strategies to manage commodity price risk on an open portfolio basis. For example, an entity may seek to maintain a stable net margin by hedging the net commodity price risk inherent in its purchases, sales and inventory holdings. To mitigate the commodity price risk from that net fixed-price position, risk managers may sell forward (or buy forward) the commodity at a fixed price using derivatives. Alternatively, an entity may dynamically manage commodity price risk for either purchases or sales – e.g. an airline that hedges the price of jet fuel, or a mining company that hedges future sales of gold.

The staff observed that the revaluation approach may be useful for some companies in accounting for their commodity price risk management activities. However, in some situations the fair value option for ‘own use’ contracts (included in the general hedge accounting proposals for IFRS 9) and cash flow hedge accounting may be better alternatives for accounting for an entity’s risk management activities.

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Some IASB members supported including a discussion about the potential application of the revaluation approach to commodity price risk in the discussion paper, and performing additional outreach.

Foreign exchange risk

The staff described how many companies, including both financial institutions and corporates, are exposed to foreign exchange risk. Companies frequently choose to economically hedge foreign exchange risk on an open portfolio basis. Risk management for foreign exchange risk is often performed centrally by a treasury function that considers:

• forecast or committed foreign currency sales or purchases;

• forecast or committed foreign currency capital expenditure;

• foreign currency risk in recognised non-monetary assets – e.g. crude oil inventory; and

• net investments in foreign operations.

The staff observed that there were some similarities between:

• foreign exchange risk management activities that consider forecast transactions while using the revaluation approach; and

• hedging the net interest margin for interest rate pipeline trades.

Therefore, the conceptual difficulties (discussed by the IASB in October 2012) of applying the revaluation approach to interest rate pipeline transactions may also be applicable to the foreign exchange risk management of forecast transactions – i.e. it may be conceptually difficult to justify recognising assets and liabilities for forecast transactions that have not yet been committed to.

The staff also observed that any benefits from implementing a revaluation approach for dynamic risk management of open portfolios for foreign exchange risk may be limited by the operational challenges in tracking foreign exchange exposures. Therefore, some companies may instead prefer to use the general hedging model to hedge foreign exchange risk.

Some IASB members supported including a discussion about the potential application of the revaluation approach to foreign exchange risk in the discussion paper, and performing additional outreach.

Next steps

The staff will continue drafting the discussion paper, whose initial focus will be documenting an overview of the revaluation model. The staff observed that they would use the comment period following publication of the discussion paper to obtain a better understanding of whether the revaluation model could be applied for other risks. They noted that once the revaluation model is described in full, it will be easier to obtain this input.

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PROJECT MILESTONES AND TIMELINE FOR COMPLETION

The current work plan anticipates significant progress in 2013, which will be necessary to maintain an effective date for IFRS 9 of 1 January 2015.

Discussionpaper

Revisedstandard?

201220102009

Asset andliability

offsetting

Impairment

Classification&

measurement

General hedgeaccounting

Source: IASB work plan – projected targets as at 4 December 2012

Standardon assets:

IFRS 9 (2009)

Supplementarydocument

ExposuredraftExposure

draft

2011

Effective

1/1/2015date

Effectivedates 1/1/2013and 1/1/2014

Exposuredraft

Standardon liabilities:IFRS 9 (2010)

Amendmentsto IFRS 7 and

IAS 32

Deferral ofeffective date

Exposuredraft – limitedamendments

1 2 3

4 5

6

7

Effectivedate?

Reviewdraft

8

2013

Final standard

Macro hedgeaccounting

9

Finalstandard?

Our suite of publications considers the different aspects of the work plan, and provides a comparison to IAS 39 where relevant.

KPMG publications

First Impressions: IFRS 9 Financial Instruments (December 2009)

• For KPMG’s most recent and comprehensive views on IFRS 9, refer to Insights into IFRS: Chapter 7A – Financial instruments: IFRS 9.

First Impressions: Additions to IFRS 9 Financial Instruments (December 2010)

• For KPMG’s most recent and comprehensive views on IFRS 9, refer to Insights into IFRS: Chapter 7A – Financial instruments: IFRS 9.

In the Headlines: Amendments to IFRS 9 – Mandatory effective date of IFRS 9 deferred to 1 January 2015 (December 2011)

New on the Horizon: ED/2009/12 Financial Instruments: Amortised Cost and Impairment (November 2009)

New on the Horizon: Impairment of financial assets measured in an open portfolio (February 2011)

New on the Horizon: Hedge Accounting (January 2011)

First Impressions: Offsetting financial assets and financial liabilities (February 2012)

New on the Horizon: Hedge Accounting (September 2012)

New on the Horizon: Classification and Measurement – Proposed limited amendments to IFRS 9 (December 2012)

1

2

3

4

5

6

7

8

9

For more information on the project see our website.

The IASB’s website and the FASB’s website contain summaries of the Boards’ meetings, meeting materials, project summaries and status updates.

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FIND OUT MORE

For more information on the financial instruments (IAS 39 replacement) project, please speak to your usual KPMG contact or visit the IFRS – financial instruments hot topics page, which includes line of business insights.

You can also go to the Financial Instruments page on the IASB website.

Visit KPMG’s Global IFRS Institute at kpmg.com/ifrs to access KPMG’s most recent publications on the IASB’s major projects and other activities.

Our IFRS – revenue hot topics page brings together our materials on the financial instruments project, including our IFRS Newsletter: Revenue. Our IFRS – insurance hot topics page brings together our materials on the insurance project, including our IFRS Newsletter: Insurance.

Our IFRS – leases hot topics page brings together our material on the leases project, including our IFRS Newsletter: Leases. Our IFRS Newsletter: The Balancing Items, which brings into focus narrow-scope amendments to IFRS, is available at kpmg.com/ifrs.

© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

Issue 4, November 2012IFRS NEWSLETTER 

REVENUE

The Boards agreed on a new approach to licences, which could have a significant impact on many sectors, including software, media and pharmaceuticals.

Phil Dowad, KPMG’s global IFRS revenue recognition leader

A licensing dealThis edition of IFRS Newsletter: Revenue examines the current

thinking on the revenue project, and what the proposals could mean for you.

In November, the Boards continued their redeliberations of the proposals in the ED, focusing on when to recognise revenue for licences, collectibility issues and when to constrain the

amount of revenue recognised. Notably, the Boards concluded on a number of issues on which they had failed to agree in earlier meetings.

Highlights

l   Recognising revenue from licensing agreements – there would be a new approach, under which licences would be analysed into two categories with different revenue profiles. Entities would

use indicators to determine whether a licence transfers a right at a point in time or provides access to intellectual property over time.

l   Collectibility – revenue would be recognised at the amount that an entity is entitled to receive, with no reduction for credit risk and no collectibility threshold. Entities would present credit loss

adjustments as an expense.

l   Constraining the cumulative amount of revenue recognised – the objective of the revenue constraint will be to avoid revenue reversals. Entities would apply an indicator approach to determine when to

apply the constraint.

IFRS NEWSLETTER: LEASES Special edition: September 2012, Issue 12

Highlights

• Boards conclude redeliberations on leases

• On-balance sheet approach for lessees

• ‘Dual’ model for income/expense recognition

• Increase in complexity for lessee and lessor accounting

• Revised exposure draft delayed until first quarter of 2013

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The future of lease accounting

The home straight? In September 2012, after many months of joint discussion, the Boards concluded their redeliberations on the lease accounting proposals published in August 2010. We can now look forward to a revised exposure draft (ED) in the first quarter of 2013, most likely with a 120-day comment period.

After a long period of redeliberation, with many twists and turns, the proposals to be included in the new exposure draft are now clear, at least in outline. This special edition of our newsletter highlights the key impacts of those proposals on lessees and lessors.

Central to the proposals will be the right-of-use model, under which all but short-term leases would be on-balance sheet for lessees. The goal of eliminating lease accounting as a source of off-balance sheet finance has become the project’s touchstone. In most instances, the proposals achieve that goal. However, the costs of achieving this goal include complexity and conceptual compromise.

The proposals will introduce new ‘dual models’ for income/expense recognition. Lessees and lessors would apply a new lease classification test, on a lease-by-lease basis, to determine which model to apply. Lease classification would depend on the extent to which the underlying asset is consumed over the lease term, and the nature of the underlying asset (real estate vs other assets).

Many leases of real estate would qualify for straight-line income/expense recognition. Lessors would achieve this by applying an approach similar to current operating lease accounting. Lessees would apply a version of the on-balance sheet right-of-use (ROU) model in which the asset is measured as a balancing figure to achieve straight-line expense recognition.

Many leases of other assets would result in an accelerated profile of income/expense recognition. Lessors would apply the new receivable and residual (R&R) model, recognising a lease receivable and a residual asset representing their interest in the underlying asset at the end of the lease term; lessors might also recognise an upfront profit. Lessees would generally recognise total lease expense on an accelerated basis, being the sum of a straight-line amortisation charge and an accelerated interest charge.

Lessees and lessors would not need to apply the models to leases with a maximum contractual term of 12 months or less. In such cases, they would not recognise lease assets and liabilities, and would recognise straight-line income/expense.

The proposals are certain to prove controversial. Several Board members have indicated that they may dissent from the proposals, and initial reaction from some user groups has been cool. We will all have a chance to comment in 2013.

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IFRS NEWSLETTER 

INSURANCEIssue 31, November 2012

The redeliberations are winding down, with an exposure draft in sight next year. Field and user input will be key in evaluating the operationality of the new model.

Joachim Kölschbach,KPMG’s global IFRS Insurance leaderKPMG International Standards Group

Moving towards global insurance accountingThis edition of IFRS Newsletter: Insurance highlights the results of the

IASB and FASB (the Boards) discussions in November 2012 on the joint insurance contracts project. In addition, it provides the current status of

the project and an expected timeline for completion.

Highlights

l   The Boards clarified that, for cash flows not subject to mirroring that are affected by asset returns:–   the discount rate would reflect the extent to which the estimated cash flows are affected by

the return from those assets; and–   an insurer would reset the locked-in discount rate that is used to present interest expense for

those cash flows when there is any change in expectations of cash flows due to changes in the crediting rate for the insurance contracts.

l   The IASB decided:–   that all rights and obligations for all insurance contracts would be presented on a net basis, with

separate line items for insurance and reinsurance contracts in the statement of financial position; and–   to require additional disclosures on contracts with cash flows contractually linked to underlying

items, the earned premium presentation and transition.

l   The FASB decided that ceding commissions that are not contingent on claims or benefits experience would be treated as a reduction of premiums ceded to the reinsurer.

l   The FASB decided on accounting for business combinations involving insurance contracts and portfolio transfers.

l   The IASB intends to undertake fieldwork as part of the re-exposure of the insurance contracts proposals.

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Issue 4, November 2012IFRS NEWSLETTER 

THE BALANCING ITEMS

Another cycle of proposed annual improvements has been issued – what are your views?

Proposed improvements to IFRS – 2011-2013 cycle

This IFRS Newsletter: The Balancing Items brings into focus the latest cycle of proposed narrow-scope amendments to IFRS.

The IASB has published Exposure Draft ED/2012/2 Annual Improvements to IFRSs – 2011-2013 Cycle as part of its annual improvements process to make non-urgent but necessary

amendments to IFRS. The exposure draft includes proposed improvements to the following standards. Comments are due by 18 February 2013.

Questions for constituents to consider

l   IFRS 1 First-time Adoption of International Financial Reporting Standards Which version of an IFRS should a first-time adopter apply in its first IFRS financial statements, if

there is a new/revised IFRS that is not yet mandatory?

l   IFRS 3 Business Combinations Does IFRS 3 apply to the formation of joint operations in IFRS 11 Joint Arrangements?

l   IFRS 13 Fair Value Measurement Do all contracts within the scope of IAS 39 Financial Instruments: Recognition and Measurement /

IFRS 9 Financial Instruments potentially qualify for the ‘portfolio exception’?

l   IAS 40 Investment Property Is the acquisition of an investment property an acquisition of a business?

KPMG CONTACTS

AmericasMichael HallT: +1 212 872 5665E: mhhall@kpmg.com

Tracy BenardT: +1 212 872 6073E: tbenard@kpmg.com

Asia-PacificReinhard KlemmerT: +65 6213 2333E: rklemmer2@kpmg.com.sg

Yoshihiro KurokawaT: +81 3 3548 5555 x.6595E: yoshihiro.kurokawa@jp.kpmg.com

Europe, Middle East and AfricaColin MartinT: +44 20 7311 5184E: colin.martin@kpmg.co.uk

Venkataramanan VishwanathT: +91 22 3090 1944E: vv@kpmg.com

AcknowledgementsWe would like to acknowledge the efforts of the principal authors of this publication: Nicolle Pietsch and Robert Sledge.

© 2012 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.

KPMG International Standards Group is part of KPMG IFRG Limited.

Publication name: IFRS Newsletter: Financial Instruments

Publication number: Issue 8

Publication date: December 2012

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International.

KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

The IFRS Newsletter: Financial Instruments contains links to third party websites not controlled by KPMG IFRG Limited. KPMG IFRG Limited accepts no responsibility for the content of such sites or that these links will continue to function. The use of third party content is to be governed by the terms of the site on which it is hosted and KPMG IFRG Limited accepts no responsibility for this.

Descriptive and summary statements in this newsletter may be based on notes that have been taken in observing various Board meetings. They are not intended to be a substitute for the final texts of the relevant documents or the official summaries of Board decisions which may not be available at the time of publication and which may differ. Companies should consult the texts of any requirements they apply, the official summaries of Board meetings, and seek the advice of their accounting and legal advisors.

kpmg.com/ifrs

IFRS Newsletter: Financial Instruments is KPMG’s update on the IASB’s financial instruments project.

If you would like further information on any of the matters discussed in this Newsletter, please talk to your usual local KPMG contact or call any of KPMG firms’ offices.