Isda workshop the practical implications of the new accounting rules
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ISDA. International Swaps and Derivatives Association, Inc. ISDA Workshop – The practical implications of the new accounting rules. 8 November 2004. Overview of current position of IFRS. Significant differences between current UK GAAP and IFRS

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ISDA Workshop – The practical implications of the new accounting rules

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International Swaps and Derivatives Association, Inc.

ISDA Workshop – The practical implications of the new accounting rules

8 November 2004

Overview of current position of IFRS

  • Significant differences between current UK GAAP and IFRS

  • Accounting for financial instruments under IFRS is rules based, UK GAAP is principles based

  • Adopted IFRS mandatory for all listed EU companies in their consolidated accounts after 1 January 2005

  • Extension of IFRS to non-consolidated accounts varies by country

  • EU adopted IAS 39 will differ from that issued by the IASB. Certain “carve outs” have been proposed by the ARC

  • Changes still being proposed to IAS 39 with four Exposure Drafts issued since January 2004

IFRS – Key standards for financial instruments accounting

IAS 39: - Recognition and measurement of financial assets and liabilities;

-Treatment of certain other non-financial items eg, commodity contracts;

-Derecognition of financial assets and liabilities

IAS 32:-Presentation of financial instruments from the perspective of the issuer;

-Provides detailed rules covering netting;

-Requires disclosures to enable a user to understand significance of financial instruments to an entity’s financial position

SIC 12:-Consolidation of Special Purpose Entities

IFRS 4:-Insurance contracts

IAS 37:-Provisions, contingent liabilities and contingent assets

The measurement categories

  • IAS 39 includes an option to designate ANY financial instrument at fair value at inception

  • Detailed guidance also provided on separating embedded derivatives from host contracts

Hedge Accounting - Key steps to achieving a qualifying hedge

  • Identify the type of hedge – fair value or cash flow or net investment

  • Identify the hedged item or transaction

  • Identify the nature of the risk being hedged

  • Identify the hedging instrument

  • Demonstrate that the hedge has and will continue to be highly effective

  • Document the hedging relationship above, including the risk management objectives and strategy for undertaking the hedge

  • Monitor effectiveness

Fair Value measurement

  • Defined as:

    “The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction”

  • It is not the amount that an entity would receive or pay in a forced transaction or distressed sale

  • Active markets – defined as those where quoted prices are readily available and representative of actual, regular market transactions. Financial Instrument valued using quoted price

  • No active market – models that are commonly used by the market are considered appropriate for valuing financial instruments

Presentation – Netting & debt v equity

  • Financial liability – a contractual obligation to deliver cash or another financial asset to an entity

  • Equity instrument – a contract that evidences a residual interest in the assets of an entity

  • Some instruments have both a liability and equity component – eg convertible bonds. The fair value of the liability should be classified in the liability section of the balance sheet and the “plug” in equity

  • Ownership by an entity of its own shares is never an asset of that entity

  • Complex rules for derivatives on own shares

  • Financial assets and liabilities may only be offset in the balance sheet when there is both:

    -a legal, enforceable right of set-off; and-an intention to exercise the right or settle simultaneously

Consolidation and Derecognition

Consolidation Principles (SIC 12)

  • An enterprise should consolidate enterprises it controls

  • Control of SPEs is determined by considering factors outlined in SIC 12

    Derecognition Principles (IAS 39)

  • Applied to transferor’s consolidated group, including SPEs if consolidated

  • Mixed model, based on both risks and rewards and control. Revised standard based on a decision tree:

    • Has there been a transfer or pass-through of cash flows?

    • Has there been a substantial change in the exposure to the risks and rewards?

    • Has there been a transfer of control (as evidenced by transferee’s ability to sell assets)?

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