The Use of IFRS for Prudential and Regulatory Purposes

Transcription

1 REPARIS A REGIONAL PROGRAM The Use of IFRS for Prudential and Regulatory Purposes IFRS 9 THE ROAD TO EUROPE: PROGRAM OF ACCOUNTING REFORM AND INSTITUTIONAL STRENGTHENING (REPARIS)

2 IFRS 9 Financial Instruments Replacement for IAS 39! Phase 1 Classification and measurement of financial assets issued in November 2009 Classification of financial liabilities issued in October 2010 as part of a revised version of IFRS 9 issued in November 2009 Guidance on de recognition and related implementation guidance from IAS39 copied into the October 2010 revised version of IFRS 9 2

3 IFRS 9 Financial Instruments (Cont d)! Phase 2 Exposure draft, Financial Instruments: Amortised Cost and Impairment published in November 2009! Phase 3 Exposure draft, Hedge Accounting published in December

4 Phase 1 Classification and measurement of financial assets! Classification on the basis of both: Business model, and Contractual cash flow characteristics! Amortised cost must be used where asset held to collect contractual cash flows and on specified dates interest. Interest is consideration for the time value of money and credit risk for the period.! Fair value all assets not measured at amortised cost. 4

5 Fair Value Option (FVO) financial assets Allowed to designate a financial asset if this eliminates or reduces an accounting mismatch! Examples Insurance assets and liabilities IFRS 9 B (a) Financial assets and liabilities that share, for example, interest rate risk that gives rise to offsetting changes in fair value but only some of the items are measured at fair value. An example is a loan and a derivative taken out to hedge the interest rate risk in the loan but hedge accounting not used IFRS 9 B (b) 5

6 Classification of Financial liabilities and measurement! All measured at amortised cost using EIR except for: FVTPL Financial liabilities arising from financial assets not derecognised IFRS Financial guarantee contracts Loan commitments at below-market rate 6

7 FVO Financial liabilities! Allowed when results in more relevant information because: or Eliminates or reduces an accounting mismatch; Group of financial liabilities and assets is managed on a fair value basis (requires documentation) 7

8 Measurement of financial assets! Initial measurement at fair value! Directly attributable transactional costs for amortised cost instruments added/subtracted! Subsequent measurement at fair value or amortised cost as appropriate according to the IFRS! Apply impairment requirements to amortised cost! Apply hedge accounting requirements to a designated financial asset 8

9 Fair value measurement and hierarchy! Quoted prices (Level 1)! Valuation technique using observable market inputs (Level 2)! Valuation technique no observable market input (Level 3) IFRS 9 B5.4.6 and IFRS 7 27A 9

10 Reclassification! Allowed when business model changed! Not allowed for any financial liability IFRS and

11 Equity investments (not trading)! At initial recognition irrevocable election to present in other comprehensive income changes in fair value! If above election, dividends are recognised in profit or loss 11

12 Phase 2 Financial Instruments: Amortised cost and Impairment! Exposure draft issued November 2009! Proposes an expected loss model! Comment period ended 30 June 2010! IASB considering practical problems with a view to a further exposure draft 12

13 Impairment proposals overview! Applies to financial assets measured at amortised cost! Estimation of future cash flows is performed at inception and updated at the end of each reporting period! Considerations include expected credit losses over the entire life! Estimates are expected values! Change in estimates recognised immediately in profit or loss can be determined on a collective or individual basis! EIR would include initial credit losses 13

14 Allowance Account! Requires the use of an allowance account! Allowance for credit losses is built up over time! Applies even if no actual losses! Does not require objective evidence of impairment or loss events 14

15 Operational considerations! Estimation uncertainty! Data availability! Timing estimates! Increased use of management expectations 15

16 Other issues! Earnings management risk! Doubt as to whether the results will be auditable! Impairment should be separate from effective interest. Users prefer credit losses reported on a separate line of income statement! Cost/benefit test not passed for the proposals 16

17 Summary of comment letter feedback! Strong support for expected loss approach! Expected cash flow approach in the ED is too difficult to apply operationally! Use of probability weighted averages in the estimate of expected cash flows too prescriptive! Too many disclosures! Concern over FASB convergence! Desire to re-expose based on revisions 17

18 IASB and FASB further consultations The Boards have discussed issues relating to methods of allocation of expected losses:! calculation of effective interest rate to include expected losses (as proposed in the ED)! separate the credit component and use discounting! allocate all initial expected loss (EL) in the first period! subsequent adjustment when estimates change (catch up) 18

19 Good book and bad book! Banks manage credit risk by distinguishing between performing ( good ) book and non-performing ( bad ) book! Good book expected losses are allocated over the life of the portfolio under this approach! Bad book has an incurred loss model where all the expected losses are recognised immediately! Issues relating to this approach: when to transfer from good to bad timing of transfer is important as it causes volatility in profit or loss 19

20 Good book and bad book (cont d)! Board members agreed not to propose a definition for items that should be included in the bad book (for example, 90 days past due)! It was agreed to include some transfer guidance in the future proposals to address concerns over too much management judgement Anna Czarniecka Financial Repor2ng Consultant annaczarniecka@2scali.co.uk 20

21 Proposed content of the ED to be published soon! Earnings management risk! Doubt as to whether the results will be auditable! Impairment should be separate from effective interest. Users prefer credit losses reported on a separate line of income statement! Cost/benefit test not passed for the proposals 21

22 Proposed content of the ED to be published soon (cont d)! Preferred approach for good book to recognise expected losses for the reasonably foreseeable future but at least 12 months! Short-term trade receivables excluded from the scope of this ED! 60 day comment period 22

23 Phase 3 Hedge Accounting! IAS 39 hedge accounting requirements! Exposure draft issued in December 2010! Problems with application of IAS 39 requirements! Overview of proposals in exposure draft 23

24 IAS 39 Hedge Accounting! Types of hedge Fair value hedge gains and losses on the risk component in hedged item and offsetting losses and gains on the hedging instrument are both recognised in profit or loss Cash flow hedge gain or loss on the hedging instrument is recognised in other comprehensive income (OCI) and recycled to profit or loss Net investment in a foreign operation hedge gain or loss on hedging instrument recognised in other comprehensive income and recycled to profit or loss on disposal of the investment 24

25 IAS 39 Hedge Accounting! Issues Users find complexity confusing Criticism that IAS 39 Hedge Accounting does not reflect an entity s risk management strategy Effectiveness testing burdensome 80%-125% test is an arbitrary limit FVO used for economic hedging because IAS 39 difficult to apply 25

26 Phase 3 - Hedge Accounting proposals! 80%-125% removed and effectiveness limited to a forward looking test! BUT ineffectiveness measured and reported in profit or loss! Portion of a commodity can be hedged if it is separately identifiable and reliably measurable! Gain or loss on hedging instrument and hedged item in a fair value hedge recognised in OCI! Ineffectiveness on a fair value hedge transferred to profit or loss 26

27 Phase 3 - Hedge Accounting proposals (cont d)! Relationship consists of eligible hedging instruments and hedged items! Formal designation and documentation at inception! Must minimise expected hedge ineffectiveness! Effectiveness tested at inception and on an ongoing basis! A designation would not fail because the hedge not as effective as originally assessed 27

28 Hedge effectiveness! Relationship consists of eligible hedging instruments and hedged items! Formal designation and documentation at inception! Must minimise expected hedge ineffectiveness! Effectiveness tested at inception and on an ongoing basis! A designation would not fail because the hedge not as effective as originally assessed 28

29 Derivative as a hedged item! Entity can designate as hedged items aggregated exposures that consist of an exposure and a derivative! Examples are: coffee purchases hedged with a futures contract viewed together as a fixed foreign currency risk exposure fixed rate foreign currency debt hedged with a crosscurrency interest swap viewed as one exposure to variable debt 29

30 Portion of a commodity! Hedge accounting allowed for risk components of non-financial items! Risk components must be separately identifiable and reliably measurable! Examples include hedging gas oil component in a supply contract using a gas oil forward contract! Increases the use of appropriate hedge accounting 30

31 Hedge of a net position! Hedging of a net position has been extended! Allowed for a group of items with offsetting cash flows! Must affect profit or loss in the same reporting period! Examples include a group of firm purchase and sale commitments hedged together for foreign exchange risk 31

32 Presentation of a fair value hedge! In the balance sheet the fair value hedge adjustment (change related to the hedged risk) presented in a separate line! Gain or loss in hedging instrument and hedged item (for changes in hedged risk) recognised in OCI! Only hedge ineffectiveness taken to profit or loss 32

33 Disclosures! Users want clearer disclosure of risk management strategy! Disclosures in the ED: risk management strategy effects of this on timing and uncertainty of future cash flows Effect of hedge accounting on primary financial statements 33

34 Disclosures (cont d) and Effective date! Present disclosures by type of risk, for example, foreign currency and interest rate risks! Tabular presentation of type of risk for each type of hedge, for example, fair value or cash flow! Effective date Prospectively for annual periods beginning on or after 1 January 2013 with earlier application permitted 34

35 Question or Comments 35