Accounting for Financial Instruments

Transcription

1 International Financial Reporting Standards Accounting for Financial Instruments (IAS 39) Executive IFRS workshop for Regulators Diplomatic Academy of Vienna Darrel Scott, IASB member The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation.

2 Overview of IAS 39 2 IAS 39 Financial Instruments: Recognition and Measurement First effective 2001 Revised Dec 2003/Mar 2004 Some subsequent revisions Being replaced in phases by IFRS 9: Financial Instruments

3 IAS 39 IAS 39 and IFRS 9 1 January Classification & Measurement IFRS 9 (2010) + ED of limited amendments General Hedge accounting* Review draft IFRS 9 Impairment Forthcoming ED * Macro hedge accounting is separated from this project

4 IAS 39 and IFRS 9 1 January 2013 continued 4 IAS 39 IFRS 9 Classification and Measurement Mandatory date: 2015 Early adoption allowed Hedge Accounting Impairment

5 Overview of IAS 39 5 IAS 39 Financial Instruments: Recognition and Measurement First effective 2001 Revised Dec 2003/Mar 2004 Some subsequent revisions Being replaced in phases by IFRS 9: Financial Instruments

6 Scope 6 Applies to all financial instruments except: subsidiaries, associates, and joint ventures leases pension obligations and assets insurance contracts provisions (IAS 37) forward contract for a business combination share-based payment transactions issuer accounting for equity instruments

7 Scope Financial guarantee contracts 7 Financial Guarantee Contract (FGC) reimbursement of holder for a loss it incurs because a specified debtor fails to make payment when due FGCs are in the scope of the FI standard if issuer used insurance accounting in the past choice between IFRS 4 and FI standard choice contract-by-contract irrevocable

8 Scope Loan commitments 8 In scope loan commitments that can be settled net in cash loan commitments for which there is a past practice of selling the resulting loans shortly after origination loan commitments designated at FVTPL loan commitments for loans at below-market interest rate Out of scope: all other loan commitments off-balance sheet with impairment test under IAS 37 derecognition for FI still applies

9 Scope Own use 9 Executory contracts that are not net cash settleable Different ways settling net in cash: explicit contractual settlement option practice of settling similar contracts net in cash (eg with counterparty, by offsetting contract or by selling contract) practice of taking delivery and selling after short time to realise dealer s margin or short term price fluctuation non-financial underlying is readily convertible to cash If entered into and continued to be held for own use scoped out of FI standard

10 Scope Differences between IAS 32 and IAS Included in IAS 32: issuer accounting for equity instruments leases (not limited as under IAS 39) forward contract for a business combination loan commitments (not limited as under IAS 39) reimbursements in conjunction with provisions (IAS 37) treasury share accounting for those purchased, sold, issued or cancelled in connection with share-based payment transactions

11 Definitions Financial asset (from IAS 32) 11 Cash, Equity in another entity Right to receive cash or another financial asset, Right to exchange instruments under potentially favourable terms or A contract that may be settled in entity s own equity Non derivative where entity will or may receive variable number of its own equity instruments, or A derivative that may be settled other than by exchanging a fixed amount of cash for a fixed number of the entity s own equity instruments IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

12 Definitions Financial liability (from IAS 32) 12 Obligation to deliver cash or another financial asset, Obligation to exchange instruments under potentially unfavourable terms or a contract that will or may be settled in entity s own equities Non derivatives That the entity is or may be obliged to deliver a variable number of its own equity instruments, or Derivatives That will or may be settled other than by exchanging a fixed amount of cash for a fixed number of the entity s own equity instruments IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

13 Definitions Equity Instrument (from IAS 32) 13 Residual interest in the assets of an entity after deducting its liabilities Excludes any instrument with an obligation to: pay cash or another financial asset or exchange financial assets and financial liabilities under potentially unfavourable conditions. If settled in the issuer s own equity, then the contract must be fixed for fixed An obligation to issue a fixed number of equity shares is not a liability because it cannot result in a loss to the entity IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

14 Definitions Derivatives 14 Financial instrument or other contract in the scope of the standard with the following characteristics (cumulative): its value changes in response to a change in a specified underlying (except if non-financial and party-specific) little or no initial net investment settled at a future date Settlement can be gross or net

15 Classification Unit of account 15 Legal Accounting Normal Contract Normal Contract Contract Bifurcation Hybrid Contract Host Contract Embedded derivative

16 Unit of account Bifurcation 16 Hybrid contract: instrument with two components embedded derivative non-derivative host contract Embedded derivative is separated from host contract if: economic characteristics not closely related to host; on standalone basis would meet definition of derivative; and hybrid contract is not FVTPL

17 Unit of account When to bifurcate 17 Hybrid contract: instrument with two components embedded derivative non-derivative host contract Embedded derivative is separated from host contract if: economic characteristics not closely related to host; on standalone basis would meet definition of derivative; and hybrid contract is not FVTPL Timing of bifurcation assessment: when entity first becomes party to the contract no subsequent reassessment unless significantly modified or reclassified out of FVTPL

18 Unit of account How to bifurcate 18 Multiple embedded derivatives in single hybrid contract separate equity from asset/liability type derivatives Disaggregate if different risks, readily separable; and independent otherwise treat as single compound derivative How to determine the terms of an embedded derivative? non-option derivative: stated or implied terms so that FV is calibrated to zero on initial recognition option type derivative: stated terms of the option feature First separate and measure embedded derivative, host is the residual

19 Unit of account Examples of embedded derivatives 19 Equity conversion feature of a convertible debt instrument Levered variable interest indexation Caps and floors on interest payments Commodity or equity indexed interest or principal payments Embedded prepayment and term extension options Inflation indexed lease payments Foreign currency payments under executory contracts Credit derivative in CDOs

20 Classification Financial Assets 20 P&L Fair Value Fair value through Profit/Loss (FVPL) Loans and receivables (LAR) Amortised Cost OCI Available for Sale (AFS) Held to Maturity (HTM)

21 Financial Assets Fair Value through Profit and Loss 21 Held for trading (mandatory classification): purpose of selling in the near term part of portfolio with recent actual short-term profit taking derivative assets (unless a hedging instrument) Designated on initial recognition (fair value option FVO): eliminates/reduces accounting mismatch managed on a fair value basis avoid bifurcation of hybrid contract

22 Financial Assets Loans and receivables 22 Asset characteristics: non-derivative financial assets fixed or determinable payments recover carrying amount unless impaired not quoted in active market not interest in pool of assets that are not LAR Entity characteristics: not intended for sale within near term not designated at initial recognition as FVTPL or AFS

23 Financial Assets Held to Maturity 23 Asset characteristics: non-derivative financial assets fixed or determinable payments fixed maturity (prepayment options) Entity characteristics: must have positive intention and ability to hold to maturity some types of sales are permitted (credit deterioration, tax law or regulatory changes, ) but must not have intention to sell in response to market or hold for just undefined period Tainting

24 Financial Assets Available for Sale 24 Asset characteristics non-derivative financial assets Residual category if a financial asset does not fit in another category it is automatically AFS Classification can also result from designation

25 Classification Financial Liabilities 25 Higher of amounts under: IAS 37 IAS 18 Financial guarantee contracts Loan commitment at belowmarket rate Fair value through Profit/Loss (FVPL) Amortised Cost

26 Financial Liabilities Fair Value through Profit and Loss 26 Held for trading (mandatory classification): purpose of repurchasing in the near term part of portfolio with recent actual short-term profit taking derivative liabilities (unless a hedging instrument or FGC) Designated by entity on initial recognition (fair value option): eliminates/reduces accounting mismatch managed on a fair value basis avoid bifurcation of hybrid contract

27 Reclassification Fair Value through Profit and Loss 27 Into generally not allowed exception: illiquid equities (derivatives) that become reliably measurable Hedging instrument at end of cash flow or net investment hedge Out of not allowed for liabilities Rare, LAR only if nonderivative, FVO was not used and no longer held for trading exception: illiquid equities, and derivatives on those, that are no longer reliably measurable

28 Reclassification Held to Maturity Into change in intention or ability so that asset will be held to maturity reclassification from FVTPL in rare circumstances Out of 28 change in intention or ability so that asset will no longer be held to maturity (can cause tainting ) tainting end of tainting

29 Reclassification Loans and Receivable 29 Into non-derivative assets for which the FVO was not used and for which the entity has the intention and ability to hold them for at least the foreseeable future Out of not allowed from FVTPL or AFS

30 Reclassification Available for Sale Into assets that no longer qualify as HTM reclassifications from FVTPL in rare circumstances illiquid equities that become reliably measurable Out of 30 reclassifications into HTM assets for which the entity has the intention and ability to hold them for at least the foreseeable future and that would have met LAR definition illiquid equities that are no longer reliably measurable

31 Initial Recognition 31 Principle: recognise a financial asset or liability when the entity becomes a party to the contract Executory contract: not recognised until at least one party has performed Trade date or settlement date accounting accounting policy choice by class of asset (treating held-fortrading as a separate class) only for regular way purchases or sales (contract must not permit net settlement) short sales: industry practice is gross liability

32 Measurement at Initial Recognition 32 Profit/loss Transaction Costs Initial carrying amount Fair value Initial carrying amount Initial carrying amount Asset or Liability Asset Liability Value at FVPL Value at other then FVPL Value at other then FVPL

33 Fair value versus transaction price 33 Differences between price and FV from: Transaction not at arm s length Transaction under duress or forced transaction Differences in unit of account Transaction not in principal or most advantageous market Part of the consideration might not be for the financial instrument itself, eg: interest free loan to subsidiary providing below-market rate loan for rebates or minimum purchase volume regarding other items

34 Subsequent measurement Fair Value through Profit and Loss 34 Balance sheet: Fair value Income statement: Change in Fair value Other Comprehensive Income: Nil

35 Subsequent measurement LAR, HTM and liabilities at amortised cost 35 Balance sheet: Amortised cost Income statement: interest revenue/expense impairments on assets gain/loss on derecognition Other Comprehensive Income: Nil

36 Subsequent measurement Available for Sale 36 Balance sheet: Fair value Income statement: debt instruments: as if at amortised cost equities: dividends and impairments Other Comprehensive Income: debt instruments: FV changes excluding amortised cost equities: FV changes excluding dividends and impairments

37 Impairment 37 IAS 39 requirements: Incurred loss approach for financial assets Impairment loss only recognised when: trigger (loss) event occurs impact can be reliably estimated Losses expected as a result of future events, no matter how likely are not recognised More than one model depending on classification 37 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

38 Impairment Collateral values 38 Key determinant in calculating loss given default (LGD) - only limited effect on probability of default (PD) Therefore primary focus is for calculating expected future cash flows once a loss event has been determined Future cash flows should be calculated taking account of all relevant information available at measurement date, therefore collateral is a current value Collateral values are disclosed under IFRS 7 for all credit exposures, both defaulted and not IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

39 Impairment Restructured loans 39 Banks and other lenders regularly renegotiate terms of loans to assist troubled borrowers Must evaluate renegotiated loan to determine if terms: have been modified, or substantially changed If modified, the loan should be evaluated for impairment based on original expected cash flows and interest rates If changed, asset should be derecognised, and a new asset recognised at fair value. The difference in values is recognised as a loss IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

40 Example Restructured loans 40 Prepayment No loss : principal has been received and can be re-used Extension of duration, interest charged at original EIR No loss, entity properly compensated for extended term Forgiveness of capital amount Loss recognized equal to present value of amount forgiven Forgiveness of interest amount Loss recognised equal to present value of amount forgiven 40 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

41 Example Restructured loans continued 41 Two loans, CU10 000, payable in 1 year, interest at 15% Repayment therefore CU at end of year one Both renegotiated: Loan 1 agrees to repay full capital, but no interest Loan 2 agrees to pay full interest, but only of capital Per IFRS: discount new cash flows at original EIR: Loan 1, expected cash flow of ( ), discounted at 15% = 8 500, loss of 1 500; Loan 2, expected cash flow of ( ), discounted at 15% = 8 500, loss of IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

42 Impairment continued 42 Criticisms of the incurred loss approach: Expected losses not recognised before trigger events overstates/front-loads interest revenue results in too little, too late recognition of loan losses triggers inconsistently applied Does not reflect the underlying economics of the transaction Need to improve usefulness of financial statements and timing of recognition of losses IASB is developing a new impairment model to address criticisms IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

43 Impairment Indicators of loss event 43 Significant financial difficulty Bankruptcy becoming probable Default/breach of contract Concession to debtor Active market disappears IBNR indicators (group level, macroeconomic factors) Additionally, for equity investments adverse change in environment (technology, market, economic, legal) significant or prolonged decline in FV

44 Impairment Measurement 44 LAR, HTM Difference between: carrying amount; and PV of future CFs Reversal of impairment if improvement related to event Available for sale Recycling of AOCI (FV-based) Reversals for debt but not for equities

45 Impairment Grouping of assets 45 Assets at amortised cost Not individually significant assets Individually significant assets Individual assessment Collective assessment Include in collective assessment if: not individually impaired; and entity has group of assets with similar risk characteristics

46 Derecognition Financial assets 46 Steps of the assessment: Determine consolidated group, ie including SPEs Determine whether assess entire asset or part of an asset Apply the derecognition criteria Assess part of asset only if it comprises: specifically identified CFs; a fully proportionate share of CFs; or a fully proportionate share of specifically identified CFs

47 Derecognition Continuing involvement 47 What is the subordination asset? Transferor s continuing involvement in the portion of the asset that was sold Transferor may have to pay 10 of consideration it received (out of cash flows from its retained interest) if there are losses in the portion sold What is the subordination liability? Transferor's conditional repayment obligation

48 Derecognition Financial assets 48 Continue Recognition Continuing involvement Have rights to CFs expired? Have rights to CFs been transferred? Obligation for pass through of CFs Transferred substantially all risks & rewards? Retained substantially all risks & rewards? Retained control of the asset? Derecognition

49 Derecognition Financial Liabilities 49 Continued recognition Extinguished? discharged cancelled expires Substantial change? (includes 10% PV test) Exchange of debt Modification Derecognition

50 Derecognition Financial Liabilities 50 Application of the criteria In-substance defeasance : payment to a third party (eg trust) does not extinguish debt without legal release from obligation NB: sinking funds are evaluated under IAS 32 ( offsetting: typically does not meet criteria) Repurchase of own debt: results in extinguishment applies even if entity is market maker in own debt or intends to resell in the near term

51 Hedging 51 Hedging and hedge accounting are two different things What is hedging? managing risks by using one financial instrument ( hedging instrument ) purposely to offset the variability in FV or cash flows of a recognised asset or liability, firm commitment, or future cash flows ( hedged item ) 51 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

52 Example Hedging 52 1/12/x1, jeweler purchases 1,000 oz of gold for $1,500 per oz for jewelry whose selling price fluctuates Jeweler at risk if gold price declines buys a forward contract (settled net in cash) to sell 1,000 oz of gold at $1,500 anytime in the next two months. at 31/12/x1 gold price is $1,400 Without hedge accounting, the $100k gain on the forward contract is shown in profit or loss in 20x1, the loss from the reduced selling price will be in profit or loss when the sale is recognised Accounting mismatch 52 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

53 What is hedge accounting? Matching the change in FV of the hedging instrument and the hedged risk in profit or loss Arises when normal accounting puts changes in economic values in different periods - accounting mismatch Hedge accounting subject to strict conditions: Formal designation and documentation of a hedge, the hedging instrument must be expected to be highly effective in achieving offsetting changes in fair value or cash flows of the hedged item that are attributable to the hedged risk. 53 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

54 Hedge accounting IAS 39 requirements Hedge accounting: Is an election Can only be applied prospectively Effectiveness testing must be performed each testing date and offset of fair value changes on hedging instrument and hedged risk must be within % of each other Hedging instrument must be a derivative (except for hedges of FX risk) Hedged item Entire item, group of items, or a hedged risk that is reliably measurable IFRS Foundation. 30 Cannon Street London EC4M 6XH UK.

55 Types of hedge accounting Fair value hedge accounting 55 Hedge exposure to fair value changes of asset or liability or firm commitment (or portion attributable to a particular risk) Recognition of gains and losses on hedged item and hedging instrument in profit and loss and adjust the carrying amount of the hedged item Examples Fixed-rate debt Inventory Firm commitment to buy a commodity at a fixed price IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

56 Example Fair value hedge accounting 56 Entity borrows 1,000, 3 years, 5% fixed rate, paid the end Hedged with derivative value linked to interest rate index End of year 1, market rate = 6% PV of debt discounted at 6% = 982 Value of the derivative declines to -20 (1000*(5%-6%)) Note: there is ineffectiveness of 2 Change in fair value of the debt ( ) vs. change in fair value of the interest rate swap (20) Passes effectiveness testing: 18/20 = 90% 56 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

57 Example Fair value hedge accounting continued 57 Financial position when loan made: Cash 1,000 Loan payable 1,000 Adjust loan end of year 1 to reflect rate change: Loan payable (hedge acct) 18 P&L (18 gain 20 loss) 2 Derivative (Liability) 20 Financial position end of year 1: Cash 1,000 Derivative (Liability) 20 Loan payable 982 Equity (P&L reserve) 2 57 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

58 Types of hedge accounting Cash flow hedge accounting 58 Hedge of exposure to variability in cash flows of: a recognised asset or liability or a highly probable forecast transaction Hedge of the foreign currency risk of a firm commitment Gains and losses on effective portion of hedge in OCI Gains and losses on ineffective portion of hedge in P&L Examples Forecast purchases/sales at prevailing commodity prices Floating-rate debt Forecast debt issuance IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

59 Example Cash flow hedge accounting 59 Entity issues 1,000 floating-rate debt Variability on cash flows from interest rate risk managed with a derivative (pay-variable, received-fixed interest rate swap) End of year 1 interest rates increase PV of cumulative change in cash flows increases by 100 But FV of swap decreases by 105 Note: Some hedge ineffectiveness which passes effectiveness test - 100/105 = 95% 59 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

60 Example Cash flow hedge accounting continued 60 Opening financial position: Loan receivable 1,000 Cash 1,000 Ineffective portion of hedge: P&L OCI (Equity) 100 Derivative (Liability) 105 Closing financial position: Loan receivable 1,000 Equity (OCI) Derivative (Liability) 105 Equity (ineffective portion of hedge) 100 (effective portion of hedge) 60 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

61 Types of hedge accounting Net investment in foreign operation 61 Hedge of a net investment in a foreign operation As defined in IAS 21 Accounted for similarly to cash flow hedges IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

62 Example Net investment in foreign operation 62 Entity A has a wholly-owned subsidiary, Entity B. Entity A has a CU functional currency and Entity B has a FCU functional currency. Entity A paid FCU100,000 for the investment in net assets at fair value of FCU80,000. Goodwill of FCU20,000 was recognised. At acquisition, Entity A loaned Entity B CU15,000 (exchange rate was FCU2:CU1). Settlement is not planned or expected in the near future. 62 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

63 Example Net investment in foreign operation continued 63 At acquisition, Entity A designates net investment in B as hedged item in its consolidated financial statements. The maximum amount that can be designated is FCU130,000 Net assets at FV: Goodwill: Loan: FCU80,000 FCU20,000 FCU30,000 If the loan was expected to be settled in the foreseeable future, it would not form part of the net investment. 63 IFRS Foundation 30 Cannon Street London EC4M 6XH UK.

64 Thank You IFRS Foundation. 30 Cannon Street London EC4M 6XH UK.