Financial Instrument
Chanhong Kim
Chief Researcher of KAI/KASB
Mar. 26. 2006
Disclaimer
The views expressed in this presentation
are those of the speaker.
Official positions of the KAI/KASB are
determined only after extensive due
process and deliberation.
Topics
 Asset Transfer with guarantee or subordinated retained
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interest
Partial derecognition
Regular way purchase or sale
Impairment of AFS equity FI
Part of Cash Flows?
Reclassification of Held for Trading FI
Relationship among Financial Instrument & etc.
Subsequent Measurement of
Loan Commitments
Derivative that is a Financial Guarantee Contract
Timing of Initial Recognition
Asset Transfer with guarantee or
subordinated retained interest
 The effect of guarantee, etc. on derecognition
 Provisions of IAS 39
- Par.16(b) : when an entity transfers ……… the rights to 90
per cent of the cash flows from a group of receivables, but
provides a guarantee to compensate the buyer for any credit
losses up to 8 per cent of the principal amount of the
receivables, paragraphs 17-23 are applied to a financial
asset (or a group) in its entirety.
- AG52 : when an entity transfers the rights to a fully
proportionate 90 per cent of the cash flows from a portfolio
of prepayable loans, but subordinates its retained interest to
provide credit enhancement to the transferee for credit
losses, paragraphs 17-23 are applied to a part of a financial
asset (or a part of a group).
Asset Transfer with guarantee or
subordinated retained interest
 Questions
(1) The detailed meaning of the transactions set out
in par.16⒝ and AG52, and the difference
between those sample transactions? Is it
appropriate in each situation?
(2) Should all guarantee result in ‘continuing
involvement’? It is not clear from AG48(a), AG51,
etc.
(3) When guarantee results in ‘continuing
involvement’, should the consideration received
due to guarantee consist associated liability?
Partial derecognition
 Accounting for debt instrument with detachable
interest-only strip.
 Provisions of IAS 39
- Par.16(a)(i) : The part comprises only specifically identified cash flows
from a financial asset (or a group). For example, when an entity enters
into an interest rate strip whereby the counterparty obtains the right to the
interest cash flows, but not the principal cash flows from a debt
instrument, paragraphs 17-23 are applied to the interest cash flows.
- Par.27,28 : The previous carrying amount(including cummulative gain
or loss in equity) of the larger financial asset shall be allocated between
the part that continues to be recognised and the part that is derecognised,
based on the relative fair values of those parts on the date of the transfer.
Partial derecognition
 Accounting for debt instrument with
detachable interest-only strip. (example)
- Detachable government bond (treasury security)
- More than 10 years’ maturity
- Can transfer interest only strip from bond
- FV of entire bond may not equal to sum of FV of Principal
and Interest  FVs are all available
Partial derecognition
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Questions
(1) On initial recognition, Can the owner of bond recognize assets for
Principal and Interest strip separately?
- Bond is composed of two different CFs.
cf.) Owner of bond with detachable stock right recognize debt
security and equity security separately.
(2) In case IAS 39 should be applied, what the entity should do when it
repurchase interest-only strip few years after it transferred
(derecognized).
(3) In case IAS 39 should be applied, how the amount of related
deferred income tax asset or liability due to fair value change be
allocated to the part sold and the part that continues to be
recognized.
Regular way purchase or sale
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Settlement date Accounting.
- Appropriate logically?
- meaning of ‘within the time frame established generally’
Provisions of IAS 39
- Par.9 : A regular way purchase or sale is a purchase or sale of a
financial asset under a contract whose terms require delivery of the
asset within the time frame established generally by regulation or
convention in the marketplace concerned.
- AG56 : …… an entity accounts for any change in the fair value of
the asset to be received during the period between the trade date
and the settlement date in the same way as it accounts for the
acquired asset. In other words, the change in value is not
recognised for assets carried at cost or amortised cost; it is
recognised in profit or loss for assets classified as financial assets
at fair value through profit or loss; and it is recognised in equity for
assets classified as available for sale.
Regular way purchase or sale
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Questions
(1) Is settlement date accounting appropriate?
- Regular way transaction is not different from spot
transaction.
- When measured at fair value, both accounting (Settlement
date & Trade date) brings out substantially the same results
- When measured at fair value, profit or loss is recognized
on unrecognized asset.
(2) Is transaction in OTC a regular way transaction?
(3) Can ‘T+30’ be ‘within the time frame established generally’
Regular way purchase or sale
 Questions
(4) Conflict between par.57 and par.59 ?
If an entity recognises financial assets using settlement
date accounting (see paragraph 38 and Appendix A paragraphs
AG53 and AG56), any change in the fair value of the asset to be
received during the period between the trade date and the
settlement date is not recognised for assets carried at cost or
amortised cost (other than impairment losses). ……
– par. 57 :
A financial asset or a group of financial assets is impaired
and impairment losses are incurred if, and only if, there is
objective evidence of impairment as a result of one or more
events that occurred after the initial recognition of the asset (a
'loss event') and that loss event (or events) has an impact on
the estimated future cash flows of the financial asset or group of
financial assets that can be reliably estimated.
- par. 59 :
Impairment of AFS equity FI
 IFRIC Draft Interpretation D18
- Should general measurement principle in IAS34 (year to
date basis) be Over-ridden?
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Provisions of IAS 39
- Par.61 : … A significant or prolonged decline in the fair
value of an investment in an equity instrument below its cost
is also objective evidence of impairment.
- Par.68 : loss amount = (cost – FV) – loss recognized before
Impairment of AFS equity FI
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Comments
(1) Impairment loss is measured using FV.
(2) The fair value of AFS reflects not only entity specific factors
but also market situations.
(3) Measured impairment loss may frequently contain the effect
from noisy factors (amount measured due to normal
fluctuations of market) that are not directly related to
impairment of specific AFS.
(4) An impairment loss recognized in a previous interim period
should not affect the measurement basis for interim
reporting, which is a ‘year to date basis’.
(5) In case the position of D18 is still to be maintained, IAS34
and/or IAS39 need to be revised rather than using
Interpretation.
Part of Cash Flows?
 Meaning of Part of CF.
 Provisions of IAS 39
- Par.16(b) : … when an entity transfers (i) the rights to the first
or the last 90 per cent of cash collections from a financial
asset (or a group of financial assets) …  paragraphs 17-23
are applied in its entirety
- BC53 and/or other paragraph :
(a) only specifically identified cash flows from a financial asset
(or a group of similar financial assets);
(b) only a fully proportionate (pro rata) share of the cash flows
from a financial asset (or a group …); or
(c) only a fully proportionate (pro rata) share of specifically
identified cash flows from a financial asset (or a group)
Part of Cash Flows?
 Questions
(1) Assume debt security that pays $100 at each year end for 5
years. What is the meaning of first or the last 90 per cent of
cash collections in par.16(b)
(2) Assume debt security that has principal amount of $1,000
and pays cash interest of $50 per year.
- In case the holder that has portfolio of similar debt
securities transferred the right to 90% of principal and 70% of
interest payment, then…?
Reclassification of Held for Trading FI
 Reclassification of held for trading FI is prohibited. Is it
appropriate?
 Provisions of IAS 39
- Par.9 : A financial asset or financial liability is classified as
held for trading if it is:
(i) acquired or incurred principally for the purpose of selling
or repurchasing it in the near term;
(ii) part of a portfolio of identified financial instruments that
are managed together and for which there is evidence of a
recent actual pattern of short-term profit-taking; or
(iii) a derivative(except for a derivative that is a financial
guarantee contract or a designated and effective hedging
instrument).
- Par.50 : An entity shall not reclassify a financial instrument
into or out of the fair value through profit or loss category
while it is held or issued
Reclassification of Held for Trading FI
 Questions
Financial instrument as held for trading may not meet the definition
of as held for trading in par. 9 of IAS 39 through changes in
circumstances while it is held or issued. For example, pledging as a
collateral, delisting or transaction restrictions by regulation etc.
It is considered to be appropriate that a financial instrument as held
for trading pledged as a collateral can not be reclassified, but a
financial instrument as held for trading under delisting or transaction
restrictions by regulation etc. can be reclassified.
IAS 39 par. 50 prohibits a financial instrument as held for trading to
be reclassified. Is it appropriate? If yes, what is the reason of such a
provision?
Relationship among Financial
Instrument & etc.
 Financial instrument, derivative and other contract
(contracts) vs. financial asset and financial liability(or
equity instrument)
 Financial instrument and other contract vs. derivative
 Provisions of IAS 32 and IAS 39
- Inference from par. 11 of IAS 32 : financial instrument, derivative
and other contract are contracts and financial asset and financial
liability(or equity instrument) are acquired or incurred from those
contracts.
- Inference from par. 9 of IAS 39 :
FI
OC
①
②
④
Scope
③
※ financial instrument : ① + ②
⑤
other contract : ④
derivative : ① + ④
scope exception : ③ + ⑤
Outside
Relationship among Financial
Instrument & etc.
 Question
⑴ Is the above inferences or below (⑵와 ⑶) understandings
appropriate? If yes, it seems more appropriate to include the
above inferences or below understandings in the Appendix of IAS
39 to make users understand better?
 Understandings
⑵ With their meanings mixed, financial instrument and derivative are
used in IAS 39 as contract or financial asset and financial liability
⑶ Par. 9 of IAS 39 defines a derivative as a financial instrument or
other contract within the scope of IAS 39 with all three of
designated characteristics. The reason is that scope provisions
are located before definition provisions in IAS 39.
Subsequent Measurement of
Loan Commitments
 Subsequent measurement of commitments to provide a
loan at a below-market interest rate
 Provision of IAS 39
- Par.47⒟ : After initial recognition, an issuer of such a commitment
shall (unless paragraph 47(a) applies) measure it at the higher of:
(i) the amount determined in accordance with IAS 37; and
(ii) the amount initially recognised (see paragraph 43) less, when
appropriate, cumulative amortisation recognised in accordance
with IAS 18.
 Question
what is the detailed accounting treatment of Par. 47⒟ of IAS 39 ? In
particular, that of Par.47⒟ (ii) ?
Derivative that is a Financial
Guarantee Contract
 Does a derivative that is a financial guarantee contract
exist ?
 Provisions of IAS 39
- Par.9 : A financial asset or financial liability is classified as held for
trading if it is:
……
(iii) a derivative(except for a derivative that is a financial guarantee
contract or a designated and effective hedging instrument).
- Par.9 : A financial guarantee contract is a contract that requires the
issuer to make specified payments to reimburse the holder for a loss
it incurs because a specified debtor fails to make payment when
due in accordance with the original or modified terms of a debt
instrument.
- AG4⒝ : A guarantee that requires payments in response to changes
in a specified credit rating or credit index is not a financial
guarantee contract and insurance contract but a derivative.
Derivative that is a Financial
Guarantee Contract
 Question
- Does a derivative that is a financial guarantee
contract exist considering financial guarantee
contract defined in IAS 39?
- If yes, what are those examples ?
Timing of Initial Recognition
 Meaning of ‘when, and only when, the entity
becomes a party to the contractual provisions of
the instrument’ in application?
 Provision of IAS 39
- Par.14 : An entity shall recognise a financial asset or a
financial liability on its balance sheet when, and only when,
the entity becomes a party to the contractual provisions of
the instrument. (See paragraph 38 with respect to regular way
purchases of financial assets.)
Timing of Initial Recognition
 Question
- What is the meaning in applying of ‘when, and only when, the
entity becomes a party to the contractual provisions of the
instrument’ ?
- It seems more appropriate to provide the specific criteria on
the timing of initial recognition, like a derecognition criteria in
IAS 39, instead of presenting some examples of applying par.
14 of IAS 39.
- For example, an entity shall recognise the financial asset as
its asset when it can control a financial asset
Thank You