1 Financial Instruments: Classification and Measurement Update

2 Scope of Classification and Measurement requirements Exposure Draft proposal The proposals apply to both financial assets and financial liabilities Subsequent IASB tentative decisions o Classification and Measurement requirements expected to be issued in November 2009 will only apply to financial assets o The existing requirements of IAS 39 will continue to apply to financial liabilities in the short term

3 Classification criteria Exposure Draft proposal The proposals introduce two classification criteria: (i) Basic loan features; and (ii) Managed on a contractual yield basis. Both criteria must be met in order to measure financial instruments at amortised cost Subsequent IASB tentative decisions o Both criteria must be considered in assessing the classification and measurement of financial assets o Second criterion (which considers the entity’s business model) to be articulated more consistently with US FASB wording o Entity’s business model must be considered first o Could have more than one business model within an entity o More application guidance on the criteria to be included in Appendix B

4 The ‘other’ measurement attribute Exposure Draft proposal The proposals require that, where the two classification criteria are met, the ‘other’ measurement attribute is amortised cost, otherwise financial instruments are measured at fair value (FV) Subsequent IASB tentative decisions The ‘other’ measurement attribute for financial assets to be amortised cost where the classification criteria are met, otherwise financial assets to be measured at FV

5 Accounting for embedded derivatives Exposure Draft proposal The proposals eliminate the bifurcation rules for derivatives embedded within financial hosts, and instead require assessment of the classification and measurement of the hybrid contract in its entirety in accordance with the classification criteria Subsequent IASB tentative decisions Applicable to financial assets only

6 Fair Value Option Exposure Draft proposal The proposals retain a fair value option at inception, only where its application eliminates or significantly reduces an accounting mismatch Subsequent IASB tentative decisions Applicable to financial assets only

7 Cost exemption for unquoted equity instruments Exposure Draft proposal Remove the cost exemption for investments in unquoted equity instruments whose fair value cannot be reliably measured Subsequent IASB tentative decisions oGuidance to be developed on when cost is the best estimate of fair value, when no or very limited information is available on a timely basis oCost will never be the best estimate of fair value for quoted equity instruments

8 Reclassification Exposure Draft proposal Reclassification is not permitted Subsequent IASB tentative decisions o Reclassification to be required when the entity’s business model changes (expected to be rare) o Reclassification from a category other than FV to FVTPL required to be measured at FV on that day, with any differences from the carrying amount taken to a separate line item in profit or loss o Reclassification from FVTPL to a category other than FVTPL will require the FV at that date to become its new carrying amount

9 Presentation option for equity instruments not held-for-trading Exposure Draft proposal o An entity can make an irrevocable election at initial recognition to present FV changes in OCI for investments in equity instruments not held for trading o Dividends would also be recognised in OCI o No impairment or recycling of gains/losses on derecognition of the asset Subsequent IASB tentative decisions o Retain irrevocable election to present FV changes from an equity investment in OCI where the instrument is not held for trading o Dividends that are a ‘return of investment’ to be recognised in profit or loss o No impairment o No recycling from OCI on disposal

10 Financial assets acquired at a discount Exposure Draft proposal Financial assets acquired at a discount that reflects incurred credit losses cannot be held with the objective of collecting cash flows Subsequent IASB tentative decisions Acquiring financial assets at a discount (that reflects incurred credit losses) does not of itself mean that instruments cannot have ‘basic loan features’ nor that they are not managed on a ‘contractual yield basis’. In principle, such instruments are assessed in accordance with the classification and measurement criteria and measured at amortised cost where both criteria are met.

11 Concentrations of credit risk Exposure Draft proposal The most senior tranche in a securitisation could be classified and measured at amortised cost, but lower level tranches that provide credit protection would be at FV Subsequent IASB tentative decisions o The issuer of a contractually linked instrument that affects concentrations of credit risk to measure the instrument based on an assessment of the classification criteria o Holders of tranches to be required to use a 'look through' approach to assess the underlying assets generating cash flows. To qualify for measurement at amortised cost, the underlying pool must be instruments that meet the classification criteria

12 Timetable Final requirements expected in November to enable early adoption for financial years ending on or after 31 December 2009 Mandatory application date expected for periods beginning on or after 1 January 2013 US FASB ED covering classification & measurement, impairment and hedging expected early 2010

13 Observations Embedded derivatives – on early adopting hybrids with financial asset hosts to be required to apply the criteria to assess the classification and measurement of the hybrid in its entirety hybrids with financial liability and non- financial hosts to be required to apply existing IAS 39 requirements which will possibly result in ‘bifurcation’ of the hybrid

14 Observations Fair Value Option – on early adopting financial assets will only be able to be designated at fair value where there is an accounting mismatch financial liabilities will be able to be designated at fair value in accordance with existing IAS 39 – that is, when (a) there is an accounting mismatch; (b) the liability is managed or its performance evaluated on a FV basis; or (c) there is an embedded derivative that cannot be separately recognised and measured

15 Observations Dividends on non-traded equity investments that are a ‘return on investment’ are presented in profit or loss IAS 27 used to require different accounting treatment for pre- and post-acquisition dividends under the cost method for subsidiaries in separate financial statements the same issues that arose in distinguishing between pre- and post-acquisition dividends may arise in identifying ‘returns on’ versus ‘returns of’ investment in allocating dividends where the election to present FV changes in OCI is made

16 Financial Instruments: Classification and Measurement Update