IAS 32, IAS 39 & IFRS 7 AA

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1 GLOBAL AUDIT LEARNING AND DEVELOPMENT IAS 32, IAS 39 & IFRS 7 AA Università degli Studi di Bergamo Anael Francillon Ivan Lucci Bergamo, 22 febbraio 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.

2 Market trends as reflected in IAS 32 and 39 Key principles of the Standard Harmonisation of markets Increased complexity Detailed disclosures All derivatives are measured at fair value Many other financial instruments measured at fair value Use of fair values Largely rules based Measurement of the hedging instrument IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 2

3 Definition of financial instruments A financial instrument is a contract that gives rise to: a financial asset of one entity and a financial liability or equity instrument of another entity Financial asset Cash Equity instrument of another entity Contractual right to receive cash or another financial asset (for example, loans and receivables) or to exchange financial assets or liabilities under potentially favourable conditions Certain contracts settled in the entity s own equity Financial liability Contractual obligation to deliver cash (for example, accounts payable) or another financial asset or to exchange financial asset or liabilities under potentially unfavourable conditions Certain contracts settled in the entity s own equity Except for certain puttable financial instruments and obligations arising only upon an entity's liquidation Equity instrument Contract evidencing a residual interest in the assets of an entity after deducting all of its liabilities IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 3

4 Categories of financial assets 4 categories of financial assets: A financial asset at fair value through profit or loss Held-to-maturity investments Loans and receivables Available-for-sale financial assets IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 4

5 Recognition All financial assets and financial liabilities, including derivatives, should be recognised in the statement of financial position when the entity becomes party to the contractual provisions of the instrument Financial fair value less transaction costs in certain circumstances Financial fair value less transaction costs in certain circumstances IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 5

6 Categories of financial assets Category Financial assets at fair value through profit or loss Loans and receivables Held-to-maturity investments Available-for-sale financial assets Definition Financial assets held for trading Derivatives, unless accounted for as a hedging instrument Financial asset designated to this category under the fair value option (must meet certain criteria) Non-derivative financial assets with fixed or determinable payments that are not quoted in an active market Non-derivative financial assets with fixed or determinable payments and fixed maturity that the entity has the positive intent and ability to hold to maturity All financial assets that are not classified in another category are classified as available-for-sale IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 6

7 Categories of financial liabilities Category Financial liabilities at fair value through profit or loss Other financial liabilities at amortised cost Definition Financial liabilities held for trading Financial liability designated as at fair value through profit or loss on initial recognition (fair value option) Derivatives unless accounted for as hedging instruments in a cash flow hedge All financial liabilities that are not classified at fair value through profit or loss IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 7

8 Initial measurement Measured at fair value on initial recognition Transaction costs are included in the initial measurement of financial instruments that are not measured at fair value through profit or loss Transaction price is presumed to be the best evidence of fair value at initial recognition, unless another amount is determined by reference to observable current market transactions or by using valuation techniques that use only data from observable markets Applies to all financial instruments whether or not negotiated on an arm s length basis (e.g., interest-free loans from a shareholder or government) IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 8

9 Subsequent measurement of financial instruments Instrument Measurement Value changes Financial assets at fair value through profit or loss Fair value P&L Held-to-maturity investments Loans and receivables Available-for-sale Amortised cost (effective interest rate) Amortised cost (effective interest rate) Fair value Not relevant (unless impaired) Not relevant (unless impaired) Other comprehensive income (OCI) (unless impaired) Financial liabilities at fair value through profit or loss Fair value P&L Other liabilities Amortised cost Not relevant Derivatives Fair value P&L IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 9

10 Guidance on fair values Active market: published price quotations No active market: valuation techniques using as many market inputs as possible IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 10

11 Amortized cost and effective interest method Amortised cost Initial recognition amount Cash received Interest income / expense = - -/+ - Impairment Amortised cost is calculated using the effective interest rate method At the end of each reporting period apply the effective interest rate method to determine interest income and interest expense IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 11

12 Reclassifications from held-to-maturity category Sales before maturity (with certain exceptions) reclassify ALL instruments Change of intent or ability reclassify ALL instruments Tainting leads to measurement at fair value And classification as AFS assets for two years IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 12

13 Reclassification of certain financial assets Reclassification out of fair value through profit or loss is Permitted for any non-derivative financial asset, which was not designated as fair value through profit or loss at initial recognition, subject to certain criteria being met Reclassification out of available for sale ( AFS ) Permitted for a financial asset in the AFS category to the loans and receivable category if certain criteria are met Assessment for separation of embedded derivatives IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 13

14 Fair value definition IAS 39.9 Value at which an asset can be obtained, Or a liability settled In a free transaction Through knowledgeable parties And available IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 14

15 Fair Value Hierarchy Level 1 Fair values measured using quoted prices (unadjusted) in active markets for identical assets or liabilities Level 2 Level 3 Fair values measured using inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices) Fair values measured using inputs for the asset or liability that are not based on observable market data (i.e. unobservable inputs) IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 15

16 Impairment requirements A financial asset or a group of financial assets is impaired if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after initial recognition; and the loss event has an impact on estimated future cash flows than can reliably be measured An impairment loss is measured as the difference between: the asset s carrying amount and the present value of estimated future cash flows - for loans and receivables or held-to-maturity investments; and the acquisition cost (net of any principal repayment and amortisation) and current fair value, less any impairment losses previously recognised for available-for-sale financial assets IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 16

17 Objective evidence of impairment for financial assets measured at amortized cost Examples of loss events that may provide objective evidence of impairment Significant financial difficulty of the issuer Payment defaults Renegotiation of asset terms due to financial difficulty of the borrower Significant restructuring due to bankruptcy or financial difficulty Disappearance of an active market for the assets concerned due to financial difficulties Measurable decrease in the estimated future cash flows of the financial asset(s) concerned IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 17

18 Impairment assessment of financial assets measured at amortized cost Objective evidence of impairment of individually significant assets? Yes Measure impairment N o Evidence of impairment for group of financial assets (including those individually assessed and not found impaired) with similar credit risk (i.e. collective assessment ) N o Yes Measure impairment collectively No impairment IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 18

19 Loans and receivables - Evaluation of impairment on a portfolio basis Future cash flows Estimate cash flows, Based on historic loss experience, Adjusted for current conditions as necessary Discount rate Original effective interest rate Losses incurred but not reported At each year end the present value of the estimated cash flows is re-calculated and impairment loss recognised for the difference between this amount and the carrying value of the portfolio. The estimated cash flows take into account incurred losses, not expected future losses When loans are identified as individually impaired they are removed from the portfolio (i.e. no longer part of collective impairment assessment) IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 19

20 Loans and receivables A possible approach to measurement of incurred losses on a portfolio basis Incurred loss Historic Emergence = loss x x period rate Portfolio balance Incurred loss defines impairment loss Historic loss rate is determined using historical data, adjusted for economic conditions existing at the end of the reporting period The emergence period is the average lag between incurrence of loss and confirmation of loss dates Incurrence loss date is the date on which impairment loss is incurred on an individual asset basis Confirmation loss date is the date on which objective evidence of impairment is identified on an individual asset basis IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 20

21 Impairment of available-for-sale equity securities Additional indicators of impairment for equity securities Adverse effects of changes in technological, market, economic or legal environment, in which the entity operates Significant or prolonged decline in the fair value of an investment below cost Equity instruments Impairment loss cannot be reversed through profit or loss as long as the asset continues to be recognised IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 21

22 Impairment of available-for-sale debt securities Indicators of impairment for debt securities (similar to those for financial assets recognised at amortised cost) Significant financial difficulty of the issuer Bankruptcy or financial reorganisation of the issuer Disappearance of an active market for the bonds concerned Measurable decrease in the estimated future cash flows Debt instruments Impairment loss reversed through profit or loss if subsequently the fair value of the debt instrument increases and the increase can be objectively related to an event occurring after the loss was recognised IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 22

23 Derecognition of a financial asset First, consolidate all subsidiaries (including all SPEs) Derecognition provisions are applied on a consolidated level Then, consider the subject of the derecognition analysis (financial asset, group of similar financial assets or a portion of a financial asset) Then, apply derecognition rules: Derecognise when contractual rights to cash flows expire or There is a transfer of a financial asset and That transfer qualifies for derecognition IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 23

24 Derecognition of a financial asset (cont.) Transfer of a financial asset requires A transfer of the contractual rights to receive the cash flows; or Meeting the pass-through requirements in IAS If financial asset has been transferred, then assess whether transfer qualifies for derecognition If substantially all risks and rewards are retained retain the asset If substantially all risks and rewards are transferred - derecognise If some but not substantially all risks and rewards have been transferred: Control -> Continuing involvement No Control -> Derecognise A very mixed model! IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 24

25 Derecognition of a financial liability Financial liability (or part thereof) is removed from the statement of financial position when it is extinguished, i.e. when the obligation is discharged or cancelled or expires IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 25

26 Need for Hedging Risk associated to financial assets or liabilities that might be subject to hedging: Interest rate risk Currency exchange risk Credit risk Market price risk IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 26

27 Benefit of hedge accounting Reporting the effects in the same period to avoid a mismatch in timing of gain and loss recognition: 1 2 Cum Hedged item 0 A Hedging instrument 20 B A Accelerate recognition of gain or loss on hedged item B Defer recognition of gain or loss on hedging instrument IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 27

28 Hedge accounting models Fair value hedges Hedge of exposure to changes in fair value of: a recognised asset or liability; an unrecognised firm commitment; or an identified portion of any of these two; that is attributable to a particular risk; and could affect profit or loss Cash flow hedges Hedge of exposure to variability in cash flows that is: attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction (including inter-company transactions); and could affect profit or loss Hedges of a net investment in a foreign operation IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 28

29 Fair value hedge accounting model Measurement of hedging instrument Changes in fair value Fair value Measurement of hedged item Fair value with respect to risk being hedged (*) Profit or loss (*) This applies even if a hedged item is otherwise measured at cost IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 29

30 Cash flow hedge accounting model Measurement of hedging instrument Fair value Effective Changes in fair value Other comprehensive income (OCI) (*) Profit or loss (*) Based on timing of earnings impact of hedged item (e.g. cost of sales, depreciation, interest) IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 30

31 Hedging instrument The following can be designated as hedging instruments: derivatives with third parties non-derivatives for a hedge of foreign currency risk only combination of two or more derivatives or non-derivatives, except for net written options A proportion of a financial instrument (for example, 50% of the fair value changes of an interest rate swap) Hedging instrument may not be designated for a portion of its remaining period to maturity Derivatives should be designated as hedging instruments in their entirety. Two exceptions to this rule: separating the intrinsic value and time value of an option and designating the intrinsic value separating the interest element and spot price element in a forward and designating the spot price element IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 31

32 Hedge accounting criteria The hedge relationship is formally designated and documented at inception of the hedge The hedge is expected to be highly effective and effectiveness is reliably measurable The hedge is assessed on an ongoing basis and remains highly effective during the entire period of the hedge designation For a cash flow hedge of a forecast transaction, the forecast transaction is highly probable IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 32

33 Hedge accounting criteria (continued) Formal documentation is required at inception of the hedge and must include: Identification of the hedging instrument and the hedged item The nature of the risk being hedged The risk management objective and strategy for undertaking the hedge How effectiveness will be assessed (prospective and retrospective) IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 33

34 Assessment of hedge effectiveness Prospective assessment At inception and at a minimum at each reporting date throughout the term of the hedge designation Highly effective in offsetting changes in fair value or cash flows Testing methods (e.g. statistical analysis, off-set methods, comparing all critical terms) Hedging results within the range of % Discontinue hedge accounting Retrospective assessment At a minimum at each reporting date and throughout the term of the hedge designation Testing methods (e.g. offset method, statistical analysis, etc.) Hedging results within the range of % 125% 100% 80% Hedge accounting; ineffectiveness to profit or loss Hedge accounting; ineffectiveness to profit or loss Hedge accounting; ineffectiveness to profit or loss Discontinue hedge accounting IFRSs do not prescribe the methods that should be used in measuring effectiveness IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 34

35 Hedges of a net investment Must meet requirements for hedge accounting A net investment hedge is a hedge of the foreign currency exposure on a net investment in a foreign operation using a derivative, or a non-derivative monetary item, as the hedging instrument Effective portion of gain or loss on hedging instrument recorded in the same manner as the foreign currency translation gain or loss i.e., in OCI Ineffective portion of gain or loss on hedging instrument recognised in profit or loss Reclassified from OCI to profit or loss as a reclassification adjustment upon disposal of net investment IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 35

36 Discontinuation of hedge accounting Future changes in fair value of hedging instrument a) Derivative b) Non-derivative (FX remeasurement) Future accounting for the hedged item Fair value hedges Continue to be recognised in profit or loss Continue to record FX remeasurement in profit or loss Apply applicable IFRS principles for the items Any hedging adjustments made previously to hedged item for which effective interest rate method is used are amortised to profit or loss by adjusting the effective interest rate Cash flow hedges Recognized immediately in profit or loss Account for FX remeasurement in profit or loss No change in accounting Effective amounts previously recorded in OCI for a forecast transaction not expected to occur within the original time period or a relatively short period thereafter N/A Reclassify from OCI to profit or loss immediately Effective amounts previously recorded in OCI for a forecast transaction that is no longer probable but still expected to occur N/A Reclassify from OCI when the transaction occurs and affects profit and loss IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 36

37 Liability or equity? Is there a contractual obligation that the issuer cannot avoid? Yes No Part Liability Equity Compound instrument Determine liability component fair value include embedded derivatives Equity is residual No gain or loss on separation Classification assessed at initial recognition and generally not subsequently revised for changes in circumstances (except for puttable financial instruments and obligations arising on liquidation) However, subsequent change in terms and conditions of instrument may require reclassification IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 37

38 Offsetting a financial asset and a financial liability A legally enforceable right to offset An intention to settle net or to realise the asset and settle the liability simultaneously & Master netting agreements Several instruments used to emulate a single instrument (synthetic instrument) Items with the same risk, but different counterparties Financial assets pledged as collateral for non-recourse liabilities Assets set aside in a trust to discharge a liability that have not been accepted by the creditor (sinking fund arrangements) Obligations as a result of losses recoverable via insurance IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 38

39 Nature and Extent of Risks Arising from Financial Instruments Qualitative disclosures For each type of risk (e.g., credit, liquidity and market) arising from financial instruments, disclose: The exposures to risk and how they arise Objectives, policies and processes for managing the risk and methods used to measure the risk Any changes to the above from the previous period IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 39

40 Nature and Extent of Risks Arising from Financial Instruments (continued) Quantitative disclosures For each type of risk arising from financial instruments, disclose: Summary quantitative data about the risk exposure as provided to key management personnel Detailed disclosures to the extent not disclosed already from the point above Concentrations of risk if not included above IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 40

41 Nature and Extent of Risks Arising from Financial Instruments (continued) Quantitative disclosures (continued) Credit risk by class of financial instruments: Maximum credit exposure (without collateral or other credit enhancements) In respect of the above, description of collateral and other credit enhancements Information about credit quality of financial assets that are neither past due nor impaired Carrying amount of renegotiated financial assets Analysis of financial assets past due or impaired In respect of above, description of collateral and other credit enhancements and unless impracticable, an estimate of their fair value IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments 41

42 Thank you Anael Francillon Senior Manager, Audit KPMG S.p.A. Via Rosa Zalivani, Treviso TV Telephone Ivan Lucci Partner, Audit KPMG S.p.A. Via Camozzi, Bergamo BG Telephone

43 2013 KPMG S.p.A., an Italian limited liability share capital company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name, logo and "cutting through complexity" are registered trademarks or trademarks of KPMG International Cooperative ("KPMG International"). Copyrighted materials may not be modified, reproduced, publicly displayed, performed, distributed or used for any public or commercial purposes without explicit written permission from the appropriate content or material provider. KPMG bears no risk, responsibility or liability in the event that a user does not obtain such explicit written permission as advised by KPMG.

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