toobigtofail bank case studysiteresources.worldbank.org/extcenfinrepref/... · see paragraph 19 of...

The views expressed in this presentation are those of the presenter,

not necessarily those of the IASB or IFRS Foundation.

International Financial Reporting Standards

TooBigToFail Bank case study

Vienna, June 2014

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

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

The requirements are set out in International Financial Reporting Standards (IFRS), as issued by the IASB at 1 January 2014, including those with an effective date after 1 January 2014, but not the IFRSs they will replace.

Disclaimer: The IFRS Foundation, the authors, the presenters and the workshop organisers do not accept responsibility for any loss caused by acting or refraining from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise and this presentation is not a form of advice or opinion.

Framework-based approach for applying IFRS


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• What are the economics of the phenomenon (eg transaction or event)?

• What information about the phenomenon is relevant for informing resource allocation decisions by existing and potential investors and lenders who cannot require information directly and that can be faithfully represented etc?

• Then consider IFRS requirements

• Make judgements to develop accounting policy

• Make judgements and estimates to apply the requirements with rigour and consistency

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Rogue trade derivatives economics + user needs


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At 31 December 20X1 what information about TBTF’s

derivatives entered into by Mr P’Ariss most relevant

(capable of making a difference) to resource allocation

decisions by the primary users—existing and potential

investors, lenders and other creditors that cannot require

TBTF to provide information directly to them—and that can

be faithfully represented?

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5 rogue trade derivatives continued


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At 31 December 20X1, using only the Conceptual

Framework which elements exist at what economic

amounts for TBTF’s derivative instruments?

Choose 1 of:

(a) Asset and income ART$2 billion

(b) Liability and expense ART$20 billion

(c) Asset/Liability and income/expense ART$0

(d) Asset ART$2 billion, liability ART$22 billion and

expense ART$20 billion

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Which IFRS specifies accounting for the derivatives?

Choose 1 of:

(a) IFRS 9/IAS 39 Financial Instruments

(b) IAS 2 Inventories

(c) IAS 16 PPE

(d) IAS 38 Intangible Assets

(e) IAS 40 Investment Property

(f) IAS 41 Agriculture

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At 31 December 20X1, in accordance with IFRS at

what amounts must TBTF report the derivative

instruments?

Choose 1 of:

(a) Asset and income ART$2 billion

(b) Liability and expense ART$20 billion

(c) Asset/Liability and income/expense ART$0

(d) Asset ART$2 billion, liability ART$22 billion and

expense ART$20 billion

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What is the fair presentation override?

See paragraph 19 of IAS 1 Presentation of Financial

Statements

What about going concern considerations? See:

• paragraphs 25 and 26 of IAS1; and

• paragraphs 14–16 of IAS 10 Events after the Reporting

Period.

Significant judgement might be needed.

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Assume TBTF is a going concern.

Is TBTF’s use of the ‘fair presentation override’ (FPO)

appropriate?

Choose 1 of:

(a) no—TBTF cannot use the FPO

(b) yes—TBTF must use the FPO

(c) Maybe yes—depending whether recognising in 20X1

only the ART$2b profit conflicts with the objective of

general purpose financial statements

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10

Assume there is significant doubt about TBTF’s ability to

continue as a going concern—will the government bailout

TBTF?


appropriate?

Choose 1 of:

(a) no—TBTF cannot use the FPO. Disclose uncertainties

(b) yes—TBTF must use the FPO.



general purpose financial statements.

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Assume TBTF is no longer a going concern—there will be

no government bailout.


appropriate?

Choose 1 of:

(a) no—TBTF cannot use the FPO. However, paragraph

25 of IAS 1 applies.

(b) yes—TBTF must use the FPO.



general purpose financial statements.

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Downgraded credit rating the economics 12

On 21/01/20X2 when TBTF’s credit rating is downgraded, a market measure of the value of the equity holders claims’ against TBTF fall by ART$50b—the fall of TBTF’s market capitalisation; and, similarly, a market measure of the value of the bond holders claims’ fall by ART$10b.

If, for simplicity, a 1:1 relationship is assumed between the market capitalisation of TBTF and its reported IFRS measure of equity, then TBTF’s resources (its assets) fell by ART$60b. ‘Proof’: Equity = Assets – Liabilities.

ART$50b loss for equity holders = ART$60b loss in TBTF’s assets – ART$10b loss carried by holders of TBTF’s debt (liabilities).

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Downgraded credit rating IFRS requirements


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However, in accordance with IFRS TBTF recognises only:

• ART$20b decrease in the fair value of recognised assets

(ART$8b recognised fair value change + ART$12b

recognised impairment)—ART$20b expense; and

• ART$10 decrease in the fair value of those recognised

liabilities that it carries at fair value—ART$10b income.

Because IFRS prohibits TBTF from recognising its

internally generated intangible assets (eg the TBTF brand),

when its credit rating is downgraded TBTF cannot

recognise the decrease in the value of its unrecognised

brand.

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Barth, Hodder, and Stubben, The Accounting Review 2008

We find that equity returns associated with credit risk changes are attenuated by the debt

value effect of the credit risk changes, as Merton (1974) predicts. We find that the

relation between credit risk changes and equity returns is significantly less negative for

firms with more debt—controlling for asset value changes, credit risk increases

(decreases) are associated with equity value increases (decreases). This result obtains

across credit risk levels. The relation is associated with changes in both expected cash

flows and systematic risk, as reflected in analyst earnings forecasts and equity cost of

capital. By inverting the Merton (1974) model, we provide descriptive evidence that if

unrecognized debt value changes were recognized in income, but not unrecognized

asset value changes, most credit upgrade (downgrade) firms would recognize lower

(higher) income. These potentially counterintuitive income effects primarily are

attributable to incomplete recognition of contemporaneous asset value changes.

However, for a substantial majority of downgrade firms we find that recognized asset

write-downs exceed unrecognized gains from debt value decreases. This mitigates

concerns that income effects from recognizing changes in debt values would be

anomalous for such firms.

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Research—fair value accounting for liabilities and own credit risk

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

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Downgraded credit rating the economics continued


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Assume: on 21 January 20X2 the market rate of interest at

which TBTF can issue 10-year fixed rate debt changed

from 5% to 10% when its credit rating was downgraded.

In other words, if TBTF issues a promise to pay

ART$1,000,000 in 10 years this would generate a cash

inflow of:

• ART$613,913 on 20 January

• but only ART$385,543 on 22 January

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Downgraded credit rating the economics continued


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Assume: on 22 January 20X2 TBTF pays ART$385,543 to repurchases the debt it issued on 20 January 20X2 for ART$613,913.

Conceptually how much has TBTF lost/gained?

Choose 1 of:

(a) gain (income) ART$228,370

(b) loss (expense) ART$228,370

(c) nil

Would your answer about the economics change if TBTF had not repurchased its debt? Why or why not?

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Downgraded credit rating IFRS requirements continued


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Assume: on 22 January 20X2 TBTF pays ART$385,543 to repurchase the debt it issued on 20 January 20X2 for ART$613,913.

How much income/expense must TBTF recognise?

Choose 1 of:

(a) income ART$228,370

(b) expense ART$228,370

(c) nil

Note: in the TBTF case study on 10 April 20X2 TBTF pays ART$7b to repurchase debt it carries at ART$10b.

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Downgraded credit rating IFRS requirements continued


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Assume: on 20 January 20X2 TBTF issues debt for

ART$613,913. On 22 January TBTF the debt is trading

actively at ART$385,543. TBTF does not repurchase it.

How much income/expense must TBTF recognise?

Choose 1 of:

(a) income ART$228,370

(b) expense ART$228,370

(c) nil

(d) income ART$228,370 if TBTF carries this liability at FV;

otherwise nil.

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Downgraded credit rating economics continued


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Is it a counterintuitive ‘accounting gimmick’ that the

downgrading of TBTF’s credit rating results in TBTF

recognising income in the period of the downgrade?

Choose 1 of:

(a) yes

(b) no

(c) it depends—what is TBTF’s business model?

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Downgraded credit rating economics continued


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Which debt measurement basis provides more useful

financial information to primary users—existing and

potential investors, lenders and other creditors who cannot

demand information—in making decisions about providing

resources to an entity? Choose 1 of:

(a) unmodified historical cost

(b) amortised cost (see IFRS 9)

(b) fair value (see IFRS 9)

(c) it depends on the entity’s business model (see IFRS 9)

(d) another measurement

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Thank you


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