IAS 39 Financial Instruments: Recognition and Measurement

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1 IAS 39 Financial Instruments: Recognition and Measurement

2 Statement of Financial Position Definitions (IAS 32) Scope Financial Instruments Apply Financial Instrument Accounting

3 Scope IAS 39 applies to all types of financial instruments except: Subsidiaries, Associates & Joint Ventures Rights & Obligations under a Lease (IAS 17), except: Impairment (Finance Lease Receivables Lessor) Derecognition (Finance Lease Payables/ Receivables) Embedded Derivatives

4 Scope IAS 39 applies to all types of financial instruments except: Employers rights under employment benefit plans (IAS 19) Financial instruments issued by the entity that meet the definition of an equity instrument under IAS 32 Insurance Contracts within the scope of IFRS 4 Contracts for contingent consideration in a Business Combination (IFRS 3)

5 Scope IAS 39 applies to all types of financial instruments except: Contracts to purchase a business at a future date in a business combination (IFRS 3) Share-based payments under IFRS 2

6 Scope IAS 39 applies to all types of financial instruments except: Contracts to purchase non-financial assets that are: Not settled in cash No practice or intention to settle net Taking physical delivery of underlying without selling it in the short term for purpose of generating short term gains

7 Time to think Kaylogs is a cereal producer and requires large amounts of maize to manufacture its product. It enters into a forward contract on an exchange to purchase tonnes of maize in 9 months time.

8 So Today 9 months Order tonnes $250/tonne Delivery of maize $270/tonne

Foreign exchange contract Broadcast license Prepaid expenses

9 Time to think A simple Statement of Financial Position. Are these Financial Intruments? Foreign exchange contract Broadcast license Prepaid expenses Government bonds Deferred revenue Income tax liability Rights / obligations arising under an operating lease Gold bullion

10 Initial Measurement Initial measurement done at FAIR VALUE For assets not at fair value include transaction costs

11 Subsequent Measurement 4 categories of financial assets: Fair Value through profit or loss Held to maturity Loans and Receivables Available-For-Sale 2 categories of financial liabilities: Fair Value through profit or loss Other Liabilities

12 Categories and measurement of Financial Assets FV through profit or loss Available-For-Sale Held to Maturity Loans and Receivables FAIR VALUE AMORTISED COST Profit or loss Other comprehensive income

13 Fair Value through Profit or Loss Two Sub-categories Designated at Fair Value through Profit or Loss Held for trading

14 Fair Value through Profit or Loss Held for trading Must be Held For Trading if it is: Part of portfolio where there is actual pattern of short-term profit taking A derivative (except for those that are designated & effective hedging instruments) Acquired / incurred principally for purpose of selling / repurchasing in near term

15 What is a Derivative? A derivative is a financial instrument with all three of the following characteristics: its value changes in response to the change in an underlying ; it requires little or no initial net investment; and it is settled at a future date

16 Derivatives Examples of underlyings? interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index

17 Derivatives How do we account for derivatives? ALWAYS Fair value through income statement EXCEPT in a cash flow hedge Common derivatives Forward exchange contracts Interest rate swaps Commodity contracts

18 At FV through Profit or Loss Can be designated as at fair value on initial recognition provided: Within scope of the standard (i.e.: it is a financial asset) Fair value can be reliably measured Once classified in above could previously NOT change it

19 General Rule: Can t reclassify a financial asset after initial recognition!

20 Reclassification Financial Assets May reclassify to another category provided no longer held for the purpose of selling or repurchasing it in the near term in RARE CIRCUMSTANCES!

21 For Example fair value through profit or loss fair value through profit or loss Available-For-Sale Held to Maturity

22 Fair Value through Profit or Loss Equity Investments listed unlisted Derivatives FECs Interest rate swaps Options Bond instruments Government bonds (Treasuries) Corporate bonds (e.g. Eskom, SANRAL)

23 Available-For-Sale Bucket account what doesn t fall into other categories ends up here! Can be designated as Available-For-Sale on initial recognition

24 Available-for-sale Equity Investments listed unlisted Derivatives FECs Interest rate swaps Options Bond instruments Government bonds (Treasuries) Corporate bonds (e.g. Eskom, SANRAL)

25 Held to Maturity Non derivative financial assets with fixed / determinable payments AND fixed maturity other than those: Designated as at fair value through profit or loss, Designated as Available-For-Sale, and Classified as loans and receivables. 2 requirements to classify as Held To Maturity: Positive intent; and Ability to hold to maturity

26 Tainting Raises doubt about ability to hold other Financial Assets to maturity if: During current or previous 2 financial years Sold, reclassified or exercised a put option On more than an insignificant amount of Held To Maturity investments Before maturity

27 Tainting Impact of tainting: All financial assets in this category must be reclassified into Available-For-Sale (INCLUDES ALL ASSETS IN GROUP) 2 full financial years penalty

28 Held to maturity Equity Investments listed unlisted Derivatives FECs Interest rate swaps Options Bond instruments Government bonds (Treasuries) Corporate bonds (e.g. Eskom, SANRAL)

29 Loans and Receivables Non-derivative instrument - with fixed / determinable payments & not quoted in an active market, other than those: Designated as at fair value through profit or loss, Designated as Available-For-Sale, Classified as held for trading or For which holder may not recover substantially all of initial investment, other than because of credit deterioration Measured at amortised cost using effective interest rate method

30 Loans and receivables Bond instruments Government bonds (Treasuries) Corporate bonds (e.g. Eskom, SANRAL) Debentures in W.Consulting (Pty) Ltd Trade & Other Receivables Intercompany loans Shareholder loans Bank accounts (even in Greek banks!)

31 Finlib Co issues a zero coupon bond for $100m that is redeemable in 3 years time. The bond is issued at a discount of $15m How is it accounted for in profit or loss on the amortised cost basis? 31

32 Example. Day 0 Year 3 Issue for $100m 0% Interest Redeem for $100m Discount: $85m Effective interest

33 Categories and measurement of Financial Liabilities FV through profit or loss FAIR VALUE though profit or loss Other Liabilities AMORTISED COST

34 Financial Liabilities Can be designated as at fair value on initial recognition provided: Within scope of the standard (i.e.: is a financial asset) Fair value can be reliably measured Once classified in above can NOT change Those that are automatically trading liabilities: Derivatives (unless effective hedging instruments)

35 Fair Value through Profit or Loss Derivatives FECs Interest rate swaps Options Own bond instruments (designated) Preference Shares (designated)

36 Financial Liabilities All other liabilities classified as Other Liabilities Account for these at amortised cost Most liabilities are in this category

37 Other liabilities Derivatives FECs Interest rate swaps Options Own bond instruments Preference Shares Trade and other payables

38 Fair Value Price quoted in an active market is best evidence of fair value Quoted - available from an exchange, dealer, broker, industry group, pricing service AND prices represent actual / regularly occurring market transactions on arm s length basis Objective is to determine price that transaction would occur at reporting date in most advantageous active market that entity has access to

39 Fair Value What about where there is no active market? Use valuation techniques, including: Recent transactions (arm s length) Reference to Fair Value of instrument that is substantially the same Discounted cash flow analysis Option pricing models (no prescriptive method) Should have as few entity-specific inputs as possible All factors market participants would consider in setting a price Consistent with accepted economic methodologies Should be periodically calibrated and tested for validity

40 Fair Value What about unlisted companies? Can use cost when the fair value is not reliably measurable: Variability in range of reasonable fair value estimates is significant for that instrument OR Probabilities of various estimates within range cannot be reasonably assessed and therefore not used in estimating fair value Consider IFRS 13 educational guidance on valuing unlisted equity instruments.

41 Hedging

42 Economic vs. Accounting Economic use of various instruments to reduce risks. Decision based on: Risk tolerance Market view Policy Accounting - achieving offset in Profit or Loss Hedging instrument is usually a derivative Tries to match recognition of Profit or Loss on hedging instrument with that of item being hedged BUT there are RULES!!

43 Hedge Item Hedged item Asset, liability, firm commitment, highly probably forecast transaction or net investment in a foreign operation that Exposes entity to risk of changes in fair value or future cash flows AND Is designated as being hedged

44 Hedging Instruments Includes Any derivative with an external party Non-derivative Financial Asset / Financial Liability - only for hedge of foreign currency risk Excludes Written options unless designated as an offset to a purchased option Own equity instruments Financial Instrument that are carried at cost because fair value cannot be measured reliably

45 Hedge Documentation Must include per hedge: Hedged item / transaction Hedging instrument Nature of risk being hedged Risk management objective Hedge strategy Method that will be used to test effectiveness

46 3 Categories of Hedges Fair value hedge Cash flow hedge Net investment in foreign operation Hedge exposure to changes in fair value attributable to specific risk & could impact Profit or Loss Hedge exposure to variability in cash flows attributable to specific risk & could affect Profit or Loss If hedging instrument is designated as hedge of reporting entity s interest in net assets in a foreign operation, gain / loss on effective portion recognised in Other comprehensive income

Financial Assets & Financial Liabilities (HKAS 39) 17 October 2008

Financial Assets & Financial Liabilities (HKAS 39) 17 October 2008 Assets & Liabilities (HKAS 39) 17 October 2008 Nelson Lam 林智遠 MBA MSc BBA ACA ACIS CFA CPA(Aust.) CPA(US) FCCA FCPA(Practising) MSCA 2006-08 Nelson 1 Assets & Liabilities Anyone who says they understand