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2011 October IFRS Conference | Financial Instruments | C&M and Impairment Day-5 outline 08:30—Accounting for financial instruments in accordance with IFRSs.

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Presentation on theme: "2011 October IFRS Conference | Financial Instruments | C&M and Impairment Day-5 outline 08:30—Accounting for financial instruments in accordance with IFRSs."— Presentation transcript:

1 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Day-5 outline 08:30—Accounting for financial instruments in accordance with IFRSs issued at 1 January 2012, but not the IFRSs they will replace IFRS 9 Financial Instruments IAS 39 FI Recognition and Measurement 10:30—IASB’s project to replace IAS 39 11:30—Quiz/discussion/case 13:30—IFRS 7 FI Disclosures 14:30—IFRS 4 Insurance Contracts 16:00—Quiz/discussion/case 11 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

2 International Financial Reporting Standards The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation. © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK. Accounting for financial instruments— IFRS 9 and IAS 39 at 1 January 2012 Joint World Bank and IFRS Foundation ‘train the trainers’ workshop hosted by the ECCB 30 April to 4 May 2012

3 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Introduction Replace IAS 39 Recognition and Measurement with IFRS 9 Financial Instruments in phases Phase I: Classification and measurement (completed) Phase II: Impairment (in progress) Phase III: Hedge accounting (in progress) Offsetting financial assets and financial liabilities (completed) 33 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

4 IFRS 9 Effective date and transition IFRS 9 effective 1 January 2015 –early application permitted Restatement of comparative financial statements not required –modified disclosures on transition 4 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

5 2011 October IFRS Conference | Financial Instruments | C&M and Impairment IFRS 9 Main changes from IAS 39 Reduces complexity –only two classification categories –single impairment model (only FI’s at amortised cost) –embedded derivatives no longer separated from financial asset host contracts Aligns measurement of financial assets with entity’s ‘business model’ and contractual cash flow characteristics of instruments ‘Own credit’ risk issue addressed Elimination of ‘tainting rules’ –that caused bonds to be measured at fair value even if the business model was to hold 55 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

6 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Classification and measurement Financial assets Fair Value (No impairment) Amortised cost (one impairment method) Contractual cash flow characteristics Business model test FVO for accounting mismatch (option) All other Instruments: Equities Derivatives Some hybrid contracts Equities: OCI presentation available (alternative) Reclassification required when business model changes 6 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

7 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Business model: objective of holding instruments is to collect contractual cash flows rather than to sell prior to contractual maturity to realise fair value changes not an instrument by instrument approach to classification assess contractual terms of instruments within such a business model 7 Financial Assets At amortised cost © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

8 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Contractual cash flow characteristics Payments represent solely principal and interest Interest is consideration for time value of money and credit risk Prepayment/extension options may qualify No ‘tainting’ rules for assets at amortised cost gains or losses from derecognising such items to be presented separately with additional disclosures 8 Financial Assets At amortised cost continued © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

9 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Alternative presentation of fair value changes in other comprehensive income (OCI) Scope investments in equity instruments not held for trading Features alternative available instrument by instrument dividends recognised in P&L no recycling, impairment or change in presentation 9 Financial Assets Equity investments: OCI alternative © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

10 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 10 Hybrid contracts Financial hostNon-financial host IAS 39 guidance retained No separation – part of classification Financial Assets Embedded derivatives © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

11 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 11 Fair value option available, if… Accounting mismatch Managed on fair value basis Embedded derivative(s) Not managed to collect contractual cash flows = FV Hybrid contracts with financial host classified in entirety *Circumstances when FVO available is unchanged for financial liabilities Financial Assets Fair Value Option (FVO) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

12 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Unquoted equities and their derivatives Fair value measurement required Cost may be an appropriate estimate of fair value –if more recent information not available or a wide range of outcomes Does not apply to equities held by financial institutions and investment funds Contractually linked and non-recourse instruments Detailed application guidance ‘Look through’ approach 12 Financial Assets Application guidance © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

13 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 13 IAS 39IFRS 9 ClassificationMany categories each with different measurement methods Two measurement bases: Amortised cost and Fair Value MeasurementIrrevocable option at initial recognition to present fair value changes of some equity investments in OCI ImpairmentDifferent impairment rules depending on category and instrument type Only debt instruments at amortised cost are tested for impairment Financial Assets Summary of Key Changes © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

14 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 14 Financial Assets Summary of Key Changes continued IAS 39IFRS 9 TaintingTainting rules for held to maturity investments No tainting rules Reclass- ification Some reclassifications permitted/required Reclassifications required if and only if business model changes Embedded derivatives Bifurcation of embedded derivatives required in some cases No separation, same classification approach (for hybrid financial assets with financial hosts) FVOAvailable if specific criteria are met Available if eliminating or significantly reducing an accounting mismatch © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

15 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 15 Example 1: Equity investment Held for trading Fair value - with changes recognised in profit or loss Not held for trading Fair value – irrevocable choice of recognising changes in profit or loss or OCI © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

16 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 16 Example 2: Debt investment (basic loan features) Held to collect contractual cash flows Amortised cost (FVO available if criteria are met) Not held to collect contractual cash flows Fair value through profit or loss © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

17 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 17 Example 3: Debt investment (embedded derivative) Hybrid contract (as a whole) has basic loan features and is Held to collect contractual CFs Whole instrument at amortised cost All other hybrid contracts with financial hosts Whole instrument at fair value through profit or loss © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

18 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Classification and measurement Financial liabilities All financial liabilities Amortise d cost FVO for mismatch, managed on FV basis and hybrids Except: Held for trading Fair value through P&L Own credit in OCI Hybrid financial liabilities are bifurcated No reclassification permitted 18 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

19 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 19 Financial Liabilities FVO and own credit What is ‘own credit’? –fair value changes in liability arising from changes in the issuer’s credit quality How is it measured? –often measured as change in margin over a benchmark interest rate What is the concern? –Gain when credit quality deteriorates, loss when credit quality improves –Reporting such gains and losses is not useful –Board’s Request for Information on measurement of liabilities –ED on classification and measurement © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

20 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 20 To address ‘own credit risk’ Retain IAS 39 measurement requirements for financial liabilities: –held for trading  fair value through P&L –hybrid liabilities  bifurcation requirements in IAS 39 –‘vanilla’ liabilities  amortised cost –maintain FVO (with current eligibility conditions) BUT Separate out ‘own credit risk’ for FVO ‘Own credit risk’ portion would be separated in a manner similar to that previously used in IFRS 7 for disclosure (IFRS 7 B4) Financial Liabilities FVO and own credit continued © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

21 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 21 Financial Liabilities FVO and own credit continued Change in FV attributable to all factors except ‘own credit risk’ Change in FV attributable to ‘own credit’ (not recycled) Profit or Loss ProfitXXX Financial liability at FVO on statement of financial position at (full) fair value Mandatory for all liabilities at FVO unless this would create or enlarge an accounting mismatch Statement of Comprehensive Income Other Comprehensive Income XXX © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

22 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Impairment IAS 39 requirements: Incurred loss approach for financial assets Impairment loss only recognised when: –trigger (loss) event occurs –impact can be reliably estimated More than one model depending on classification 22 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

23 2011 October IFRS Conference | Financial Instruments | C&M and Impairment 23 Impairment continued 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 23 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

24 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 24 Hedging ‘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’) © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

25 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 25 Example: Hedging On 1/12/X1 a jeweler purchased 1,000 ounces of gold for $1,500 per ounce to manufacture jewelry whose selling price fluctuates with changes in the gold price Jeweler is concerned the gold price will decline. –buys an option (settled net in cash) to sell 1,000 ounces of gold at $1,500 anytime in the next two months. The option is measured at FVTPL. –at 31/12/X1 gold price is $1,400 –the $100,000 gain on the option is recognised in profit or loss in 20X1– but the ‘loss’ attributable to the reduced selling price will affect profit or loss in the future (ie when the sale is recognised). Accounting ‘mismatch’ © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

26 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 26 What is hedge accounting? Matching the change in FV of the hedging instrument and the hedged item in profit or loss for the same period Hedge accounting is only an issue when normal accounting would put the two fair value changes in different periods—sometimes referred to as an ‘accounting mismatch’ © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

27 Hedge accounting recognises the offsetting effects of changes in the fair values or the cash flows of the hedging instrument and the hedged item. Strict conditions must be met before hedge accounting is possible: –there must be formal designation and documentation of a hedge, including the risk management strategy for the 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. 27 Hedge accounting IAS 39 requirements © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

28 Hedge exposure to fair value changes of recognised asset or liability or unrecognised firm commitment (or portion of these attributable to a particular risk) Hedge of the foreign currency risk of a firm commitment Recognition of gains and losses on hedged item and hedging instrument in profit and loss and adjust the carrying amount of the hedged item (if not measured at cost) 28 Types of hedge accounting Fair value hedge accounting © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

29 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 29 Example: Fair value hedge accounting Entity borrows 1,000, 3 years, 5% fixed rate, payable at the end, measured at amortised cost Hedged with a derivative whose value is linked to an interest rate index End of year 1, market rate = 6%. FV of 50 payable in 1 year at 6% + 1,050 payable 2 years at 6% = 50 x ,050 x = 982, but this 18 ‘gain’ is not recognised Value of the derivative declines to -20 Note: there is small ineffectiveness = 2 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

30 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 30 Financial position when loan made: Cash1,000 Loan payable1,000 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: Cash1,000 Derivative (Liability) 20 Loan payable982 Equity2 Example: Fair value hedge accounting continued © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

31 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 31 Hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction Hedge of the foreign currency risk of a firm commitment Portion of hedge deemed to be effective: gains and losses recognised in OCI Portion of hedge deemed to be ineffective: gains and losses recognised in profit or loss Treatment of cumulative gains or losses differs based on what ‘type’ of asset or liability is subsequently recognised Types of hedge accounting Cash flow hedge accounting © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

32 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 32 Entity sells goods for 1,000 floating rate 3-year note receivable Interest rate risk managed with a derivative (interest rate swap) End of year 1 interest rates increase – PV of cumulative cash flows increase by 100 But FV of swap decreases by 105 Note: Some hedge ineffectiveness Example: Cash flow hedge accounting © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

33 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 33 Opening financial position: Receivable1,000 Equity1,000 Ineffective portion of hedge: P&L5 (ineffective portion of hedge) OCI (Equity)100 Derivative (Liability)105 Closing financial position: Receivable1,000 Equity (OCI) 100 (effective portion of hedge) Derivative (Liability) 105 Equity995 example continued next slide... Example: Cash flow hedge accounting continued © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

34 Hedge of a net investment in a foreign operation –as defined in IAS 21 –accounted for similarly to cash flow hedges 34 Types of hedge accounting Net investment in foreign operation © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

35 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 35 Entity A has a wholly-owned subsidiary, Entity B. Entity 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 CU15,000 (exchange rate was FCU2:CU1). Settlement is not planned or expected in the near future. Example: Net Investment in foreign operation © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

36 © 2011 IFRS Foundation 30 Cannon Street | London EC4M 6XH | UK | 36 At acquisition, Entity A designates the net investment in Entity B as a hedged item in its consolidated financial statements. The maximum amount that can be designated is FCU130,000 Net assets at FV:FCU80,000 Goodwill:FCU20,000 Loan:FCU30,000 If the loan was expected to be settled in the foreseeable future, it would not form part of the net investment. Example: Net Investment in foreign operation continued © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

37 2011 October IFRS Conference | Financial Instruments | C&M and Impairment Questions or comments? Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation. 37 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.

38 38 The requirements are set out in International Financial Reporting Standards (IFRSs), as issued by the IASB at 1 January 2012 with an effective date after 1 January 2012 but not the IFRSs they will replace. The IFRS Foundation, the authors, the presenters and the publishers do not accept responsibility for loss caused to any person who acts or refrains from acting in reliance on the material in this PowerPoint presentation, whether such loss is caused by negligence or otherwise. 38 © IFRS Foundation | 30 Cannon Street | London EC4M 6XH | UK.


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