International Accounting
Standards Committee
Issues Under IAS 39
AAA August 2000
Presentation by
Paul Pacter
Hong Kong
paupacter@deloitte.com.hk
IAS 39: SCOPE
• All enterprises
• All financial instruments
except:
-- Investments in subs,
associates, joint ventures
-- Leases, pensions, insurance
-- Enterprise’s own equity
-- Commodity contracts - intent
to take delivery
IAS 39: RECOGNITION
• All financial assets and
liabilities must be on the
balance sheet
• Including all derivatives
TRADE DATE OR
SETTLEMENT DATE?
Purchases: Normal purchases
either at trade or settlement
date, with recognition of certain
value changes if settlement
date accounting is used.
Sales: Settlement date.
INITIAL MEASUREMENT:
FINANCIAL ASSETS AND
LIABILITIES
• Initially all financial
instruments measured at cost
(which is fair value at
acquisition)
• Transaction cost included in
initial measurement.
SUBSEQUENT MEASUREMENT:
FINANCIAL ASSETS
All financial assets are
remeasured to fair value
(includes those held for trading
or available for sale) except the
following, which are measured at
amortised cost . . .
SUBSEQUENT
MEASUREMENT AT COST
• Originated loans and
receivables
• Fixed maturity investments:
must intend and be able to hold
to maturity
• Some unquoted equities and
derivatives indexed to them (if
FV is not measurable reliably)
STRICT TESTS FOR HELD
TO MATURITY
• Single sale taints all for two
years -- unless sale is due to
isolated event beyond
company’s control and not
reasonably anticipated
• Variable rate debt can be HTM
Note: Intent and ability tests do
not apply to originated loans
SUBSEQUENT MEASUREMENT:
FINANCIAL LIABILITIES
• Most financial liabilities at
original recorded amount less
principal repayments and
amortisation
• Derivatives and liabilities held
for trading (short sales)
remeasured to fair value
REPORTING FV CHANGE:
Single enterprise-wide option:
• Entire FV change in P&L OR
• In P&L only FV changes
relating to trading assets and
liabilities. FV changes for nontrading assets in equity until
sold, then in P&L. Derivatives
always trading (unless hedging)
IMPAIRMENT OF FINANCIAL
ASSETS CARRIED AT COST
• Recognise impairment losses
Individually for large assets
• Portfolio allowed for groups
• Strict indicators of impairment
• Write-down to P&L
• Reversal to P&L up to cost
• Interest after impairment
MEASURING IMPAIRMENT
Impairment is the excess of
carrying amount over
estimated recoverable amount
(present value of cash flows
discounted at the loan's
original effective interest rate).
DERECOGNITION
Assets: Control surrendered -transferee can sell or pledge
the asset. Transferor can only
reacquire at fair value.
Liabilities: Debtor must be
legally released. No insubstance defeasance.
Partial transfer: Split based on
relative FV.
COLLATERAL
If a debtor gives collateral to
the creditor, and the creditor
can sell or repledge:
• Debtor recognises the
collateral given as a receivable
• Creditor recognises the
collateral received as an asset
and the obligation to repay the
collateral as a liability.
FINANCIAL GUARANTEES
• Not normally recognised
under IAS 39 (eg letter of credit)
• Recognised in some
derecognitions
• If recognised, measure at fair
value until expiration
HEDGE ACCOUNTING
Designating a financial
instrument as an offset to the
change in FV or cash flows of
an asset, liability, commitment,
or forecasted transaction.
Offsetting effects recognised in
P&L in the same period.
HEDGE ACCOUNTING
Permitted by IAS 39 in certain
circumstances. The hedging
relationship must be:
• Clearly designated
• Measurable
• Actually effective
FAIR VALUE HEDGE
• Hedge value change in a
recognised asset or liability
• Gain or loss on hedging
instrument and on hedged item
are both recognised in P&L
• Carrying amount of hedged
item is adjusted even if
otherwise carried at cost
CASH FLOW HEDGE
• Hedge cash flow risk from an
asset or liability, firm
commitment, or forecasted
transaction
• Gain or loss on hedging
instrument in equity until the
hedged transaction hits P&L,
then “recycled” to P&L
DISCONTINUE HEDGE
ACCOUNTING WHEN
• Hedging instrument expires
(unless replaced or rolled over)
• Hedge is no longer effective
• The forecasted transaction (if
any) is no longer expected to
occur
BASIS ADJUSTMENT
• When the forecasted
transaction occurs, should the
amount reported in equity
become part of the cost of
the asset or liability?
• IAS 39: Yes.
DISCLOSURE - 1
• Most IAS 32 disclosures
continue
• How FV was determined
• FV changes in P&L or equity?
• Current period amounts in
P&L or equity
• Cumulative amounts in equity
DISCLOSURE - 2
• Describe risk management
policies
• Detailed Info if FV cannot be
reliably measured
• Detailed info about hedges
• Reclassifications of financial
• instruments (e.g. HTM to AFS)
• Impairment and reversals
EFFECTIVE DATE
• 1 January 2001
• Companies are gearing
up now
• Postponement
probability: nil
TRANSITION
• Recognise all financial assets
and liabilities, including those
that had not previously been
recognised
• If a previously designated
hedge does not meet IAS 39
conditions, no more hedge
accounting
MAINTENANCE OF IAS 39
• Minor amendments to IAS 39:
proposed in June
• Implementation Guidance
Q&A: Special Implementation
Guidance Committee is hard at
work. Over 100 Q&A exposed.
E66 JUNE 2000
Minor Amendments to IAS 39
• Symmetry of trade or
settlement date for both
purchases and sales.
• Lender will no longer
recognise collateral received
from a borrower. Disclose.
• Assess impairment
individually for large assets.
IMPLEMENTATION GUIDANCE
• Being developed by IASC staff
• Reviewed by Implementation
Guidance Committee (IGC)
• Exposed for public comment
• Reviewed and approved by
IGC
IMPLEMENTATION GUIDANCE
Proposed Guidance:
• Batch 1, 8 May 2000: 75 Q&A
• Batch 2,12 May 2000: 33 Q&A
• Batch 3 dealing with bank
issues under development
• Goal: finish by October
• Status: Best practice guidance
SAMPLE GUIDANCE ISSUES
• Are credit rating guarantee
contracts excluded? No.
• Are credit default derivatives
excluded? Yes.
• Is gold bullion a financial
asset? No.
• Are offsetting loans, one fixed
one variable, a derivative? Yes.
SAMPLE GUIDANCE ISSUES
• Company sells a put on its own
shares, and has right to settle in
shares. Liability or equity? Eq.
• What if holder of put has right
to require cash settlement? Liab.
• Are royalties based on volume
of revenue a derivative? No.
• Contract to convert currency at
fixed rate -- derivative? Yes.
SAMPLE GUIDANCE ISSUES
• Is fixed price forward contract
to purchase a commodity a
derivative? Depends on intent.
• Is 5-year put option to sell
building for fixed price a
derivative? Depends on history.
• Are bank loan commitments
derivatives? Yes, but not treated
if ‘regular way’ draw-down.
SAMPLE GUIDANCE ISSUES
• If embedded is separated from
host, show separately on
balance sheet? Yes.
• Can investment in convertible
bond be HTM? No.
• Transferor has right of first
refusal. Derecognise? Yes.
• HTM not tainted by sale ‘close
to maturity’. What is close?
Under 3 months.
SAMPLE GUIDANCE ISSUES
• HTM not tainted by sale after
collecting ‘substantially all’
principal. Substantially = 90%.
• Does reclass from HTM to
trading taint all HTM? Yes.
• Is amortisation of premium or
discount interest (P&L) or part
of FV change (equity)? Interest.
SAMPLE GUIDANCE ISSUES
• Can impairment of individual
loan or HTM asset be ‘ignored’
by a portfolio approach? No.
• Can partial term hedging get
hedge accounting? Yes.
• Do bank ‘internal hedges’ get
hedge accounting? Only if risk
ultimately laid off with 3rd party.
SAMPLE GUIDANCE ISSUES
• Can hedge effectiveness be
assessed on after-tax basis?
Yes.
• If hedge is considered highly
(but not 100%) effective, does
ineffective portion go to equity?
No, P&L.
• Is purchase of bond when
issued an originated loan? Yes.
SAMPLE GUIDANCE ISSUES
• Is commitment to issue debt at
fixed rate accounted for as a
derivative? No.
• Derecognise receivables “sold”
with guarantee for all credit
losses? Yes.
• Amortise discount or premium
on variable rate investment to
next repricing date or maturity?
Depends on intent to hold.
JOINT WORKING GROUP ON
FINANCIAL INSTRUMENTS
• IASC and 10 standard setters
• Exploring full fair value model
• Developing proposal by end of
2000
• Each standard-setter will invite
comments on JWG discussion
paper
KEY TENTATIVE JWG
CONCLUSIONS
• Applies to all enterprises
• Scope similar to IAS 39, but:
-- Includes financial guarantee
contracts
-- Includes weather derivatives
-- Applies to acquired servicing
assets and liabilities
-- Applies to any obligation that
either party can settle in cash
KEY TENTATIVE JWG
CONCLUSIONS
• Recognition of financial
instruments: similar to IAS 39
• Embedded derivative
provisions are similar to IAS 39
except will be fewer separations
because more hybrids are
measured at fair value
KEY TENTATIVE JWG
CONCLUSIONS
Derecognition: when enterprise
is no longer a party to the
contractual rights or
obligations (“transferor has no
continuing interest”)
KEY TENTATIVE JWG
CONCLUSIONS
• Would derecognise in most
repo and securities lending
transactions.
• Note: Transferee must have
substance in its own right or
transferred asset is isolated in
bankruptcy.
KEY TENTATIVE JWG
CONCLUSIONS
• Measure all financial
instruments at fair value when
recognised initially.
• Remeasure to fair value at
each reporting date.
KEY TENTATIVE JWG
CONCLUSIONS
Fair value is exit price based on
market transactions
Best: observed market price
If exchange traded, closing
price minus commissions
If dealer traded, bid prices for
assets, asked prices for
liabilities
KEY TENTATIVE JWG
CONCLUSIONS
Best: market price for identical
instrument.
• If not available, use price for
similar instrument.
• If more than one market, use
most advantageous price.
KEY TENTATIVE JWG
CONCLUSIONS
• If no market price for identical
or similar, use a DPV cash flow
model based on general market
info (interest rates, FX rates,
commodity prices) riskadjusted as necessary.
• If not able to make reliable FV
estimate currently, use most
recent FV estimate.
KEY TENTATIVE JWG
CONCLUSIONS
• Ignore non-contractual
aspects of financial instruments
(such as future deposits by
depositors or additional
purchases by credit card
holders).
• But do consider behavioural
expectations (eg prepayments).
KEY TENTATIVE JWG
CONCLUSIONS
If financial instrument is
denominated in foreign
currency:
• For forward contract use
forward rate
• For all others use spot rate
KEY TENTATIVE JWG
CONCLUSIONS
• Do not adjust market price for
size of holding.
• Procedures for determining
fair value must be documented.
• Fair values are generally
determinable, at reasonable
cost, and are practicably
implementable.
KEY TENTATIVE JWG
CONCLUSIONS
Reported value of liabilities
should reflect changes in an
enterprise’s own
creditworthiness.
KEY TENTATIVE JWG
CONCLUSIONS
• All gains and losses arising
from changes in fair value of
financial instruments reported
in net income when they arise.
• Interest revenue and interest
expense should be calculated
on a fair value basis using
current YTM, not contractual.
KEY TENTATIVE JWG
CONCLUSIONS
• Separately report FV changes
relating to impaired loan assets.
• All forms of hedge accounting
prohibited, including hedges of
commitments or forecasted
transactions. Certain ‘hedging’
note disclosures allowed.
CONCLUSION
• The participating JWG
countries are committed to
invite comments
• None has said they accept or
reject the JWG conclusions
• IASC consideration will await
the new restructured IASC
Board