EUROPEAN UNION ACCOUNTING RULE 11 FINANCIAL INSTRUMENTS

Transcription

1 EUROPEAN UNION ACCOUNTING RULE 11 FINANCIAL INSTRUMENTS

2 Page 2 of 35 I N D E X 1. Objective Scope Definitions Presentation Recognition Measurement Initial measurement Subsequent measurement Recognition of gains and losses Reclassification Impairment Derecognition Derecognition of financial assets Derecognition of financial liabilities Disclosures Effective date Reference to other rules Annex: Categories of financial instruments... 35

3 Page 3 of Objective The objective of this EU Rule is to prescribe the accounting treatment of financial instruments. It applies to the classification, presentation, recognition and measurement of financial instruments as well as to disclosures on financial instruments and the risk management in the context of financial instruments. 2. Scope This EU accounting rule applies to accounting for all financial instruments (financial assets, financial liabilities, equity instruments, financial guarantees) in the consolidated financial statements of the European Union except: Interests in controlled entities, joint ventures and associates (except where otherwise required by EU Rule 1); Trust funds falling under the scope of EU Rule 1 (Group accounting); Leases (EU Rule 8); Pre-financing (EU Rule 5); Employers rights and obligations under EU Rule 12 (Employee benefits); Loan commitments in the scope of EU Rule 10 (Provisions); and Non-exchange transactions under EU Rule 17 (revenue from non-exchange transactions): initial recognition and initial measurement of rights and obligations. 3. Definitions The following terms are used in this accounting rule with the meanings specified: 1) Assets are resources controlled by an entity as a result of past events and from which future economic benefits or service potential are expected to flow to the entity. 2) A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. 3) A financial asset is any asset that is: (a) Cash; (b) An equity instrument of another entity; (c) A contractual right: (i) To receive cash or another financial asset from another entity; or (ii) To exchange financial assets or financial liabilities with another entity under conditions that are potentially favorable to the entity; or (d) A contract that will or may be settled in the entity s own equity instruments and is:

4 Page 4 of 35 (i) A non-derivative for which the entity is or may be obliged to receive a variable number of the entity s own equity instruments; or (ii) A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity s own equity instruments. For this purpose the entity s own equity instruments do not include puttable financial instruments classified as equity instruments, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments, or instruments that are contracts for the future receipt or delivery of the entity s own equity instruments. 4) A financial liability is any liability that is: (a) A contractual obligation: (i) To deliver cash or another financial asset to another entity; or (ii) To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the entity; or (b) A contract that will or may be settled in the entity s own equity instruments and is: (i) A non-derivative for which the entity is or may be obliged to deliver a variable number of the entity s own equity instruments; or (ii) A derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of the entity s own equity instruments. For this purpose the entity s own equity instruments do not include puttable financial instruments classified as equity instruments, instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation and are classified as equity instruments, or instruments that are contracts for the future receipt or delivery of the entity s own equity instruments. 5) An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities. 6) Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm s length transaction. 7) A puttable instrument is a financial instrument that gives the holder the right to put the instrument back to the issuer for cash or another financial asset or is automatically put back to the issuer on the occurrence of an uncertain future event or the death or retirement of the instrument holder. 8) A derivative is a financial instrument or other contract within with all three of the following characteristics: (a) Its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the "underlying");

5 Page 5 of 35 (b) It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and (c) It is settled at a future date. 9) A financial asset or financial liability at fair value through surplus or deficit is a financial asset or financial liability that is classified as held for trading. A financial asset or financial liability is classified as held for trading if it is: (a) It is acquired or incurred principally for the purpose of selling or repurchasing it in the near term; (b) On initial recognition it is 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 profittaking; or (c) It is a derivative (except for a derivative that is a financial guarantee contract). 10) Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturity that an entity has the positive intention and ability to hold to maturity other than: (a) Those that the entity upon initial recognition classifies as held for trading; (b) Those that the entity designates as available for sale; and (c) Those that meet the definition of loans and receivables. 11) Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market other than: (a) Those that the entity intends to sell immediately or in the near term, which shall be classified as held for trading; (b) Those that the entity upon initial recognition designates as available for sale; or (c) Those for which the holder may not recover substantially all of its initial investment, other than because of credit deterioration, which shall be classified as available for sale. An interest acquired in a pool of assets that are not loans or receivables (e.g., an interest in a mutual fund or a similar fund) is not a loan or receivable. 12) Available-for-sale financial assets are those non-derivative financial assets that are designated as available for sale or are not classified as (a) loans and receivables, (b) held-to-maturity investments or (c) financial assets at fair value through surplus or deficit. 13) 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. 14) The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference

6 Page 6 of 35 between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility. 15) The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability (or group of financial assets or financial liabilities) and of allocating the interest revenue or interest expense over the relevant period. 16) The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, an entity shall estimate cash flows considering all contractual terms of the financial instrument (e.g., prepayment, call and similar options) but shall not consider future credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts. There is a presumption that the cash flows and the expected life of a group of similar financial instruments can be estimated reliably. However, in those rare cases when it is not possible to estimate reliably the cash flows or the expected life of a financial instrument (or group of financial instruments), the entity shall use the contractual cash flows over the full contractual term of the financial instrument (or group of financial instruments). 17) Monetary items are units of currency held and assets and liabilities to be received or paid in fixed or determinable number of units of currency. 18) An embedded derivative is a component of a hybrid (combined) instrument that also includes a non-derivative host contract with the effect that some of the cash flows of the combined instrument vary in a way similar to a stand-alone derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract. A derivative that is attached to a financial instrument but is contractually transferable independently of that instrument, or has a different counterparty from that instrument, is not an embedded derivative, but a separate financial instrument. 19) Derecognition is the removal of a previously recognised financial asset or financial liability from an entity s statement of financial position. 20) 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. 21) Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability (e.g. fees and commissions paid to agents, brokers, advisers, dealers, levies by regulatory agencies and security exchanges and transfer taxes and duties, but not debt premiums, discounts, financing costs, or internal administrative or

7 Page 7 of 35 holding costs). An incremental cost is one that would not have been incurred if the entity had not acquired, issued or disposed of the financial instrument. 22) Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation. 23) Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. 24) Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. 25) Liquidity risk is the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. 26) Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk, and other price risk. 27) Other price risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices (other than those arising from interest rate risk or currency risk), whether those changes are caused by factors specific to the individual financial instrument or its issuer, or factors affecting all similar financial instruments traded in the market. 28) A financial asset is past due when a counterparty has failed to make a payment when contractually due. 29) An EU entity in the sense of this accounting rule is an entity that prepares financial statements in accordance with the Financial Regulation of the European Union and falls under the consolidation scope of the EU. 4. Presentation Liabilities and net assets / equity 1) An EU entity that issues financial instruments shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument. 2) When an EU entity applies the definitions in point 3 to determine whether a financial instrument is an equity instrument rather than a financial liability, the instrument is an equity instrument if, and only if, both conditions (a) and (b) below are met. (a) The instrument includes no contractual obligation: (i) To deliver cash or another financial asset to another entity; or (ii) To exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavorable to the issuer.

8 Page 8 of 35 (b) If the instrument will or may be settled in the issuer s own equity instruments, it is: (i) A non-derivative that includes no contractual obligation for the issuer to deliver a variable number of its own equity instruments; or (ii) A derivative that will be settled only by the issuer exchanging a fixed amount of cash or another financial asset for a fixed number of its own equity instruments. For this purpose the issuer s own equity instruments do not include puttable instruments that would be classified as equity instruments, instruments that oblige the issuer to deliver pro rata shares of its net assets on liquidation, or instruments that are contracts for the future receipt or delivery of the issuer s own equity instruments. A contractual obligation, including one arising from a derivative financial instrument, that will or may result in the future receipt or delivery of the issuer s own equity instruments, but does not meet conditions (a) and (b) above, is not an equity instrument. 3) In general, a critical feature in differentiating a financial liability from an equity instrument is the existence of a contractual obligation of one party to the financial instrument (the issuer) either to deliver cash or another financial asset to the other party (the holder) or to exchange financial assets or financial liabilities with the holder under conditions that are potentially unfavorable to the issuer. Although the holder of an equity instrument may be entitled to receive a pro rata share of any dividends or similar distributions declared, or distributions of the net assets/equity, the issuer does not have a contractual obligation to make such distributions because it cannot be required to deliver cash or another financial asset to another party. 4) The substance of a financial instrument, rather than its legal form, governs its classification on the entity s statement of financial position (balance sheet). Substance and legal form are commonly consistent, but not always. Some financial instruments take the legal form of equity instruments but are liabilities in substance and others may combine features associated with equity instruments and features associated with financial liabilities. 5) Risk capital loans (included in risk capital operations) are formally (legally) loans granted by the EU to investors in the MEDA region. The investor is required to reimburse the value of its underlying equity investment at the end of the term of the loan. Although formally a loan, the financial asset has the characteristics and substance of an equity investment and so is accounted for as such. Offsetting 6) A financial asset and a financial liability shall be offset and the net amount presented in the statement of financial position when, and only when, an EU entity: (a) Currently has a legally enforceable right to set off the recognised amounts; and (b) Intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. In accounting for a transfer of a financial asset that does not qualify for derecognition, the entity shall not offset the transferred asset and the associated liability.

9 Page 9 of 35 7) Offsetting a recognised financial asset and a recognised financial liability and presenting the net amount differs from the derecognition of a financial asset or a financial liability. Although offsetting does not give rise to recognition of a gain or loss, the derecognition of a financial instrument not only results in the removal of the previously recognised item from the statement of financial position but also may result in recognition of a gain or loss. 8) The conditions set out in paragraph 6 are generally not satisfied and offsetting is usually inappropriate when: (a) Several different financial instruments are used to emulate the features of a single financial instrument (a "synthetic instrument"); (b) Financial assets and financial liabilities arise from financial instruments having the same primary risk exposure (e.g., assets and liabilities within a portfolio of forward contracts or other derivative instruments) but involve different counterparties; (c) Financial or other assets are pledged as collateral for non-recourse financial liabilities; (d) Financial assets are set aside in trust by a debtor for the purpose of discharging an obligation without those assets having been accepted by the creditor in settlement of the obligation (e.g., a sinking fund arrangement); or (e) Obligations incurred as a result of events giving rise to losses are expected to be recovered from a third party by virtue of a claim made under an insurance contract. 5. Recognition 1) An EU entity shall recognise a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes a party to the contractual provisions of the instrument. 2) Where assets arise out of contractual arrangements in a non-exchange transaction and otherwise meet the definition of a financial instrument, they are: (a) Initially recognised in accordance with EU Rule 17 (Revenue from nonexchange transactions); (b) Initially measured: (i) At fair value using the principles in EU Rule 17; and (ii) Taking account of transaction costs that are directly attributable to the acquisition of the financial asset, where the asset is subsequently measured other than at fair value through surplus or deficit. 3) An embedded derivative shall be separated from the host contract and accounted for as a derivative if, and only if: (a) The economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract; (b) A separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and

10 Page 10 of 35 (c) The hybrid (combined) instrument is not measured at fair value with changes in fair value recognized in surplus or deficit (i.e., a derivative that is embedded in a financial asset or financial liability at fair value through surplus or deficit is not separated); and (d) The underlying information is available taken into account with cost/benefit considerations in mind. If an embedded derivative is separated, the host contract shall be accounted for under this accounting rule if it is a financial instrument, and in accordance with other appropriate accounting rules if it is not a financial instrument. 6. Measurement 6.1 Initial measurement Fair value 1) When a financial asset or financial liability is recognised initially, an entity shall measure it at its fair value plus, in the case of a financial asset or financial liability not at fair value through surplus or deficit, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. 2) The best evidence of the fair value of a financial instrument at initial recognition, in an exchange transaction, is the transaction price (i.e., the fair value of the consideration given or received) unless the fair value of that instrument is evidenced by comparison with other observable current market transactions in the same instrument (i.e., without modification or repackaging) or based on a valuation technique whose variables include only data from observable markets. Financial support loans without market 3) Financial support loans granted by EU entities from borrowed funds are measured at nominal value since these are not concessionary loans. Rather, these are loans granted with the sole purpose of providing financial support to the beneficiary thus there is an absence of an active comparable market. The EU only borrows money so as to provide this assistance so therefore it does not seek out alternate investment opportunities for borrowed monies and thus there is no basis of comparison with market rates. Examples of such financial support facilities include the European Financial Stabilisation Mechanism and Balance of Payments loans. In accordance with paragraph 2 the transaction price is considered to be at fair value at day 1 of the transaction. The nominal interest rate thus is considered the effective interest rate reflecting the fact that there is no active market or similar transactions to compare with. Concessionary loans 4) If the consideration given or received does not reflect the fair value of the financial instrument, the fair value of the financial instrument is estimated, using a valuation technique. For example, the fair value of a long-term loan or receivable that carries no interest (concessionary loan) can be estimated as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument (similar as to currency, term, type of interest rate

11 Page 11 of 35 and other factors) with a similar credit rating. The difference between the consideration given (loan) and the fair value at inception is recognised as an expense or a reduction of revenue unless it qualifies for recognition as some other type of asset (e.g. in accordance with EU Rule 17). Where the loan is a transaction with owners in their capacity as owners, for example, where a controlling entity provides a concessionary loan to a controlled entity, the difference may represent a capital contribution, i.e., an investment in an entity, rather than an expense. Financial guarantees 5) Financial guarantee contracts are initially recognised at fair value. The premium received represents the fair value unless there is evidence to the contrary. 6) In the EU, several programmes provide financial guarantees to the participants at no or at nominal consideration. At initial recognition, where no fee is charged or where the consideration is below fair value, an EU entity should firstly assess whether there are quoted prices available in an active market for financial guarantee contracts directly equivalent to that entered into. If this is the case, the financial guarantee should be recognised as financial liability using the market price. In case no active market for a directly equivalent guarantee contract exists; the EU entity applies the principles of EU Rule 10 to the financial guarantee contract at initial recognition. 7) Financial guarantees at no consideration and with a low probability of losses (i.e. guarantees under the guarantee fund for external actions) and the unexpected loss of financial guarantees with premium within the framework agreement of the co-operation agreement between the EU and the EIB (i.e. guarantees under the risk sharing finance facility and LGTT) shall be accounted for in accordance with EU Rule 10 (provisions) as contingent liability. In case the probability of an expected loss of financial guarantees within the framework agreement of the cooperation agreement between the EU and the EIB exceeds 50%, it shall be immediately recognised as an expense in the economic outturn account. Financial guarantees issued at no consideration in the context of the budgetary instruments managed by the EIB are accounted for in accordance with EU Rule Subsequent measurement Financial assets 1) For the purpose of measuring a financial asset after initial recognition, financial assets are classified into the following four categories defined in point 3 above: (a) Financial assets at fair value through surplus or deficit; (b) Held-to-maturity investments; (c) Loans and receivables; and (d) Available-for-sale financial assets. These categories apply to measurement and surplus or deficit recognition under this accounting rule. See the Annex for some examples.

12 Page 12 of 35 2) After initial recognition, an entity shall measure financial assets, including derivatives that are assets, at their fair values, without any deduction for transaction costs it may incur on sale or other disposal, except for the following financial assets: (a) Loans and receivables as defined in point 3, which shall be measured at amortised cost using the effective interest method; (b) Held-to-maturity investments as defined in point 3, which shall be measured at amortised cost using the effective interest method; and (c) Investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured and derivatives that are linked to and must be settled by delivery of such unquoted equity instruments, which shall be measured at cost. All financial assets except those measured at fair value through surplus or deficit are subject to review for impairment in accordance with point 7 below. If a financial instrument that was previously recognised as a financial asset is measured at fair value and its fair value falls below zero, it is a financial liability measured in accordance with paragraph 3. Financial liabilities 3) After initial recognition, an entity shall measure all financial liabilities at amortised cost using the effective interest method, except for: (a) Financial liabilities at fair value through surplus or deficit. Such liabilities, including derivatives that are liabilities, shall be measured at fair value except for a derivative liability that is linked to and must be settled by delivery of an unquoted equity instrument whose fair value cannot be reliably measured, which shall be measured at cost. (b) Financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies. Paragraphs 9 and 11 of point 8 below apply to the measurement of such financial liabilities. (c) Financial guarantee contracts as defined in point 3. After initial recognition, an issuer of such a contract shall (unless (a) or (b) applies) measure it at the higher of: (i) The amount determined in accordance with EU Rule 10 (Provisions); and (ii) The amount initially recognised (see 6.1 above) less, when appropriate, cumulative amortisation recognised in accordance with EU Rule 4 (Revenue from exchange transactions). Financial guarantee contracts as described in point 6.1 paragraph 7 are subsequently measured in accordance with EU Rule 10. (d) Commitments to provide a loan at a below-market interest rate. After initial recognition, an issuer of such a commitment shall (unless paragraph (a) applies) measure it at the higher of: (i) The amount determined in accordance with EU Rule 10; and (ii) The amount initially recognised less, when appropriate, cumulative amortisation recognised in accordance with EU Rule 4.

13 Page 13 of 35 4) In some cases, financial assets are acquired at a deep discount that reflects incurred credit losses. Entities include such incurred credit losses in the estimated cash flows when computing the effective interest rate. 5) If an entity revises its estimates of payments or receipts (e.g. due to restructuring of debt instruments), the entity shall adjust the carrying amount of the financial asset or financial liability (or group of financial instruments) to reflect actual and revised estimated cash flows. The entity recalculates the carrying amount by computing the present value of estimated future cash flows at the financial instrument s original effective interest rate (see also paragraph 6 of point 7). The adjustment is recognised in surplus or deficit as revenue or expense. Fair value hierarchy Quoted prices 6) The best evidence of fair value is quoted prices in an active market. Fair value is not an amount that an EU entity would receive or pay in a forced transaction, involuntary liquidation or distress ale it reflects rather the credit quality of the instrument. A financial instrument is regarded as quoted in an active market if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm s length basis. Fair value is defined in terms of a price agreed by a willing buyer and a willing seller in an arm s length transaction. The objective of determining fair value for a financial instrument that is traded in an active market is to arrive at the price at which a transaction would occur at the end of the reporting period in that instrument (i.e., without modifying or repackaging the instrument) in the most advanta-

14 Page 14 of 35 geous active market to which the entity has immediate access. However, the entity adjusts the price in the more advantageous market to reflect any differences in counterparty credit risk between instruments traded in that market and the one being valued. 7) The appropriate quoted market price for an asset held or liability to be issued is usually the current bid price and, for an asset to be acquired or liability held, the asking price. When an entity has assets and liabilities with offsetting market risks, it may use mid-market prices as a basis for establishing fair values for the offsetting risk positions and apply the bid or asking price to the net open position as appropriate. When current bid and asking prices are unavailable, the price of the most recent transaction provides evidence of the current fair value as long as there has not been a significant change in economic circumstances since the time of the transaction. If conditions have changed since the time of the transaction (e.g., a change in the risk-free interest rate following the most recent price quote for a government bond), the fair value reflects the change in conditions by reference to current prices or rates for similar financial instruments, as appropriate. Similarly, if the entity can demonstrate that the last transaction price is not fair value (e.g., because it reflected the amount that an entity would receive or pay in a forced transaction, involuntary liquidation or distress sale), that price is adjusted. The fair value of a portfolio of financial instruments is the product of the number of units of the instrument and its quoted market price. If a published price quotation in an active market does not exist for a financial instrument in its entirety, but active markets exist for its component parts, fair value is determined on the basis of the relevant market prices for the component parts. Valuation technique 8) If the market for a financial instrument is not active, an entity establishes fair value by using a valuation technique. The objective of using a valuation technique is to establish what the transaction price would have been on the measurement date in an arm s length exchange motivated by normal operating considerations. 9) Valuation techniques include using recent arm s length market transactions between knowledgeable, willing parties, if available, reference to the current fair value of another instrument that is substantially the same, discounted cash flow analysis and option pricing models. If there is a valuation technique commonly used by market participants to price the instrument and that technique has been demonstrated to provide reliable estimates of prices obtained in actual market transactions, the entity uses that technique. The chosen valuation technique makes maximum use of market inputs and relies as little as possible on entity-specific inputs. It incorporates all factors that market participants would consider in setting a price and is consistent with accepted economic methodologies for pricing financial instruments. Periodically, an entity calibrates the valuation technique and tests it for validity using prices from any observable current market transactions in the same instrument (i.e., without modification or repackaging) or based on any available observable market data. 10) If a rate is quoted in an active market, the EU entity uses the market-quoted rate as an input into valuation technique to determine fair value. If the market-quoted rate does not include credit risk or other factors that market participants would include in valuing the instrument, the entity

15 Page 15 of 35 adjusts for those factors. Factors to be considered are time value of money, credit risk, foreign currency exchange prices, commodity prices, equity prices, volatility, prepayment/surrender risk and servicing costs for a financial instrument. 11) A valuation technique would be expected to arrive at a realistic estimate of the fair value if (a) it reasonably reflects how the market could be expected to price the instrument and (b) the inputs to the valuation technique reasonably represent market expectations and measures of the risk-return factors inherent in the financial instrument. Therefore, a valuation technique (a) incorporates all factors that market participants would consider in setting a price and (b) is consistent with accepted economic methodologies for pricing financial instruments. In accordance with EU Rule 2 (point 6) the balance between benefit and cost, a pervasive constraint, must be considered when deciding on the use of valuation techniques. 12) In applying discounted cash flow analysis, an entity uses one or more discount rates equal to the prevailing rates of return for financial instruments having substantially the same terms and characteristics, including the credit quality of the instrument, the remaining term over which the contractual interest rate is fixed, the remaining term to repayment of the principal and the currency in which payments are to be made. Short-term receivables and payables with no stated interest rate may be measured at the original invoice amount if the effect of discounting is immaterial. 13) The fair value of investments in equity instruments that do not have a quoted market price in an active market and derivatives that are linked to and must be settled by delivery of such an unquoted equity instrument is reliably measurable if (a) the variability in the range of reasonable fair value estimates is not significant for that instrument or (b) the probabilities of the various estimates within the range can be reasonably assessed and used in estimating fair value. 14) There are many situations in which the variability in the range of reasonable fair value estimates of investments in equity instruments that do not have a quoted market price and derivatives that are linked to and must be settled by delivery of such an unquoted equity instrument is likely not to be significant. Normally it is possible to estimate the fair value of a financial asset that an entity has acquired from an outside party. However, if the range of reasonable fair value estimates is significant and the probabilities of the various estimates cannot be reasonably assessed, an entity is precluded from measuring the instrument at fair value. 6.3 Recognition of gains and losses 1) Interest, dividends or similar distributions, losses, and gains relating to a financial instrument or a component that is a financial liability shall be recognised as revenue or expense in surplus or deficit. Distributions to holders of an equity instrument shall be debited by the entity directly to net assets. Transaction costs incurred on transactions in net assets shall be accounted for as a deduction from net assets. 2) The classification of a financial instrument as a financial liability or an equity instrument determines whether interest, dividends or similar distributions, losses, and gains relating to that instrument are recognised as revenue or expense in surplus or deficit. Thus, dividends or similar

16 Page 16 of 35 distributions on shares wholly recognised as liabilities are recognised as expenses in the same way as interest on a bond. Changes in the fair value of an equity instrument are not recognised in the financial statements. 3) Gains and losses related to changes in the carrying amount of a financial liability are recognised as revenue or expense in surplus or deficit. 4) A gain or loss arising from a change in the fair value of a financial asset or financial liability shall be recognised, as follows. (a) A gain or loss on a financial asset or financial liability classified as at fair value through surplus or deficit shall be recognised in surplus or deficit. (b) A gain or loss on an available-for-sale financial asset shall be recognised directly in net assets through the statement of changes in net assets (except for impairment losses; see point 7; and foreign exchange gains and losses; see paragraph 5 below), until the financial asset is derecognised, at which time the cumulative gain or loss previously recognised in net assets shall be recognised in surplus or deficit. However, interest calculated using the effective interest method is recognised in surplus or deficit. Dividends or similar distributions on an available-for-sale equity instrument are recognised in surplus or deficit when the entity s right to receive payment is established. 5) Any foreign exchange gains and losses on monetary assets and monetary liabilities are recognised in surplus or deficit. A monetary available-for-sale financial asset is treated as if it were carried at amortised cost in the foreign currency. Accordingly, for such a financial asset, exchange differences resulting from changes in amortised cost are recognised in surplus or deficit and other changes in carrying amount are recognised in accordance with paragraph 4(b). For available-for-sale financial assets that are not monetary items (e.g., equity instruments), the gain or loss that is recognised directly in net assets under paragraph 4(b) includes any related foreign exchange component. 6) For financial assets and financial liabilities carried at amortised cost, a gain or loss is recognised in surplus or deficit when the financial asset or financial liability is derecognised or impaired, and through the amortisation process. 6.4 Reclassification 1) An EU entity shall not classify any financial assets as held to maturity if the EU entity has, during the current financial year or during the two preceding financial years, sold or reclassified more than an insignificant amount of held-to-maturity investments before maturity (more than insignificant in relation to the total amount of held-to-maturity investments) other than sales or reclassifications that: (a) Are so close to maturity or the financial asset s call date (e.g., less than three months before maturity) that changes in the market rate of interest would not have a significant effect on the financial asset s fair value; (b) Occur after the entity has collected substantially all of the financial asset s original principal through scheduled payments or prepayments; or

17 Page 17 of 35 (c) Are attributable to an isolated event that is beyond the entity s control, is non-recurring and could not have been reasonably anticipated by the entity. 2) An entity: (a) Shall not reclassify a derivative out of the "fair value through surplus or deficit" category while it is held or issued; and (b) May, if a financial asset is no longer held for the purpose of selling or repurchasing it in the near term (notwithstanding that the financial asset may have been acquired or incurred principally for the purpose of selling or repurchasing it in the near term), reclassify that financial asset out of the fair value through surplus or deficit category if the requirements in paragraph 3 or 5 are met. An entity shall not reclassify any financial instrument into the fair value through surplus or deficit category after initial recognition. 3) A financial asset to which paragraph 2(b) applies (except a financial asset of the type described in paragraph 5) may be reclassified out of the fair value through surplus or deficit category only in rare circumstances. 4) If an entity reclassifies a financial asset out of the fair value through surplus or deficit category in accordance with paragraph 3, the financial asset shall be reclassified at its fair value on the date of reclassification. Any gain or loss already recognised in surplus or deficit shall not be reversed. The fair value of the financial asset on the date of reclassification becomes its new cost or amortised cost, as applicable. 5) A financial asset to which paragraph 2(b) applies that would have met the definition of loans and receivables (if the financial asset had not been required to be classified as held for trading at initial recognition) may be reclassified out of the fair value through surplus or deficit category if the entity has the intention and ability to hold the financial asset for the foreseeable future or until maturity. 6) A financial asset classified as available for sale that would have met the definition of loans and receivables (if it had not been designated as available for sale) may be reclassified out of the available-for-sale category to the loans and receivables category if the entity has the intention and ability to hold the financial asset for the foreseeable future or until maturity. 7) If an entity reclassifies a financial asset out of the fair value through surplus or deficit category in accordance with paragraph 5 or out of the available-for-sale category in accordance with paragraph 6, it shall reclassify the financial asset at its fair value on the date of reclassification. For a financial asset reclassified in accordance with paragraph 5, any gain or loss already recognised in surplus or deficit shall not be reversed. The fair value of the financial asset on the date of reclassification becomes its new cost or amortised cost, as applicable. For a financial asset reclassified out of the available-for-sale category in accordance with paragraph 6, any previous gain or loss on that asset that has been recognised directly in net assets in accordance with paragraph 4(b) of point 6.3 shall be accounted for in accordance with paragraph 11 below.

18 Page 18 of 35 8) If, as a result of a change in intention or ability, it is no longer appropriate to classify an investment as held to maturity, it shall be reclassified as available for sale and remeasured at fair value, and the difference between its carrying amount and fair value shall be accounted for in accordance with paragraph 4(b) of point ) Whenever sales or reclassification of more than an insignificant amount of held-to-maturity investments do not meet any of the conditions in point 2, any remaining held-to-maturity investments shall be reclassified as available for sale. On such reclassification, the difference between their carrying amount and fair value shall be accounted for in accordance with paragraph 4(b) of point ) If a reliable measure becomes available for a financial asset or financial liability for which such a measure was previously not available, and the asset or liability is required to be measured at fair value if a reliable measure is available, the asset or liability shall be remeasured at fair value, and the difference between its carrying amount and fair value shall be accounted for in accordance with paragraph 4 of point ) If, as a result of a change in intention or ability or in the rare circumstance that a reliable measure of fair value is no longer available or because the two preceding financial years referred to in paragraph 1 have passed, it becomes appropriate to carry a financial asset or financial liability at cost or amortised cost rather than at fair value, the fair value carrying amount of the financial asset or the financial liability on that date becomes its new cost or amortised cost, as applicable. Any previous gain or loss on that asset that has been recognised directly in net assets in accordance with paragraph 4(b) of point 6.3 shall be accounted for as follows: (a) In the case of a financial asset with a fixed maturity, the gain or loss shall be amortised to surplus or deficit over the remaining life of the held-to-maturity investment using the effective interest method. Any difference between the new amortised cost and maturity amount shall also be amortised over the remaining life of the financial asset using the effective interest method, similar to the amortisation of a premium and a discount. If the financial asset is subsequently impaired, any gain or loss that has been recognised directly in net assets is recognised in surplus or deficit in accordance with paragraph 10 of point 7. (b) In the case of a financial asset that does not have a fixed maturity, the gain or loss shall remain in net assets until the financial asset is sold or otherwise disposed of, when it shall be recognised in surplus or deficit. If the financial asset is subsequently impaired any previous gain or loss for available for sale financial assets that has been recognised directly in net assets is recognised in surplus or deficit in accordance with paragraph 10 of point Impairment Impairment indicators 1) An EU entity shall assess at the end of each reporting period whether there is any objective evidence that a financial asset or group of financial assets is impaired. If any such evidence exists,

19 Page 19 of 35 the entity shall apply paragraph 6 below (for financial assets carried at amortised cost), paragraph 9 below (for financial assets carried at cost) or paragraph 10 below (for available-for-sale financial assets) to determine the amount of any impairment loss. 2) 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. It may not be possible to identify a single, discrete event that caused the impairment, rather the combined effect of several events may have caused the impairment. Losses expected as a result of future events, no matter how likely, are not recognised. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the holder of the asset about the following loss events: (a) Significant financial difficulty of the issuer or obligor; (b) A breach of contract, such as a default or delinquency in interest or principal payments; (c) The lender, for economic or legal reasons relating to the borrower s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider; (d) It becoming probable that the borrower will enter bankruptcy or other financial reorganisation; (e) The disappearance of an active market for that financial asset because of financial difficulties; or (f) Observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including: (i) Adverse changes in the payment status of borrowers in the group (e.g., an increased number of delayed payments); or (ii) National or local economic conditions that correlate with defaults on the assets in the group (e.g., an increase in the unemployment rate in the geographical area of the borrowers, a decrease in oil prices for loan assets to oil producers, or adverse changes in industry conditions that affect the borrowers in the group). 3) The disappearance of an active market because an entity s financial instruments are no longer publicly traded is not evidence of impairment. A downgrade of an entity s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment (e.g., a decline in the fair value of an investment in a debt instrument that results from an increase in the risk-free interest rate). 4) In addition to the types of events in paragraph 2, objective evidence of impairment for an investment in an equity instrument includes information about significant changes with an adverse effect that have taken place in the technological, market, economic or legal environment in which the issuer operates, and indicates that the cost of the investment in the equity instrument