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Accounting for Financial Instruments

Accounting for Financial Instruments. Ed Jenkins. 25 November 2010. Agenda. IFRS 9 Impairment Hedge Accounting IFRS / US GAAP convergence Disclosure. Timeline. IFRS 9. Consolidation. Derecognition. Fair value measurement. Other topics. Other IAS 39- related changes.

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Accounting for Financial Instruments

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  1. Accounting for Financial Instruments Ed Jenkins 25 November 2010

  2. Agenda • IFRS 9 • Impairment • Hedge Accounting • IFRS / US GAAP convergence • Disclosure

  3. Timeline

  4. IFRS 9

  5. Consolidation Derecognition Fair value measurement Other topics Other IAS 39- related changes Replacement of IAS 39 Business combinations • Liabilities • Insurance contracts • Financial statement presentation • Revenue recognition Phase 1 Classification & Measurement Phase 2 Impairment Phase 3 Hedging Key areas of focusThe IASB’s primary focus in 2009 was financial instruments

  6. IFRS 9 Financial InstrumentsSummary of requirements • Issued: 12 November 2009 • Effective: 1 January 2013 • Scope: Classification and measurement of financial assets Categories in existing IAS 39 New categories FVTPL – Trading & FVO FVTPL L&R Amortised cost HTM AFS

  7. Fair value through profit or loss Amortised cost Classification criteria Based on: Business model; and Contractual terms of the financial asset All financial instruments: Not classified and measured at amortised cost; or Designated at fair value through profit or loss

  8. Amortised cost criteria • Business model test • Objective of the business model is to hold the financial assets in order to collect the contractual cash flows • Business model determined by key management personnel • Applied before assessing the contractual terms of the financial asset • Contractual terms • Give rise solely to payments of principal and interest on the principal outstanding • No leverage within the contractual terms Note: Interest is defined as the return for time value of money and credit risk

  9. Financial Liabilities • IASB issued amendments to IFRS 9 to address financial liabilities in October 2009 • Board previously decided to retain IAS 39 accounting for financial liabilities not subject to Fair Value Option (FVO) • Loan commitments and financial guarantees have been scoped out • Changes in FV due to own credit risk will be presented in OCI unless to do so would generate an accounting mismatch

  10. Transition Rules: • Mandatory Effective Date of 1 January 2013 • Early Adoption Permitted and if adopted before 1 January 2012, no need to restate prior periods • IFRS 9 is to be applied retrospectively, in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, with certain exceptions • Differences arising from the adoption of IFRS 9 between the carrying amounts and fair value of financial assets are to be recognized in the opening retained earnings of the reporting period that includes the date of initial application • When an entity adopts the standard, it is required to assess whether it meets the condition described above regarding the business model of managing its financial assets on the basis of the facts and circumstances that exist at the initial application date

  11. Impairment

  12. Impairment • IAS 39 looks at impairment on an “Incurred Loss basis” • IASB issued an ED in 2009, proposing a more forward looking method of impairment and established an Expert Panel to consider the question • Exposure Draft generated considerable debate around factors such as: • Recognition of initial expected losses • The interaction between testing for performing and non-performing loans • How changes in expected losses are recognised • Work ongoing on project but an IFRS is expected in Q2 2011

  13. Basic concepts Interest revenue is recognised on the basis of expected cash flows, including initial expected credit losses (‘ECF approach’) Changes in expected credit losses will be recognised in the income statement, although timing is still uncertain Re-estimation of expected cash flows at each reporting date Estimates of amounts and timing of cash flows are the probability-weighted possible outcomes Amortised Cost and Impairment: Expected Cash Flow Approach

  14. Hedge Accounting

  15. Hedge Accounting • IASB are undertaking a comprehensive review of hedge accounting • A key aim is simplification • Alignment of risk management and accounting • Currently only tentative decisions have been made • Exposure Draft expected by the end of 2010 • IFRS to be issued Q2 2011

  16. Hedge Accounting – Main Messages • Derivatives permitted as hedged items • Accounting for Cashflow Hedges unchanged • New rules for Fair Value Hedging • New hedge effectiveness guidelines

  17. Hedge Accounting: Tentative Decisions • Hedge effectiveness: • The principal that all hedge ineffectiveness must be identified, measured and booked is driving many of the complex proposals. • Tentative decisions include: • No bright-line (i.e. no 80% to 125% range) – ‘best hedging relationship that is available’ suggested, although no clarity as to what this means in practice. • The characteristics of the hedging relationship determines what method of assessment is appropriate (e.g. qualitative or quantitative) • The assessment is forward looking and performed at inception and on an ongoing basis • All hedge ineffectiveness must be recognised (includes effect of credit risk AND time value of money (difference in timing of cash flows)

  18. Hedge Accounting: Tentative Decisions • Discontinuation • Mandatory discontinuation when hedging relationship ceases to meet the qualifying criteria • Dedesignation prohibited when all the qualifying criteria are still met. (Further guidance is required to fully understand this point, although any additional restrictions could cause issues with current designations). • Derivative as hedged item • Derivatives can be designated as hedged items in several situations including when hedged exposure is a combination of a derivative and a non- derivative.

  19. Hedge Accounting: Tentative Decisions • Rebalancing • Occurs when some of the variables affecting the hedging relationship changes beyond the expected level or sources of ineffectiveness • Is a continuation of an existing hedge in specific circumstances. Depends upon whether the risk management objective still applies • Tentative approach to hedge accounting • Cash flow hedging is unchanged. • Fair value hedging – some changes: • Cumulative gain or loss on the hedged item attributable to the hedged risk as a separate line item in the balance sheet Hedged item’s carrying amount not changed • The fair value changes for hedging instruments and hedged items are taken to other comprehensive income and any ineffectiveness is transferred immediately to profit or loss – this would be operationally cumbersome

  20. Hedge Accounting: Tentative Decisions • Transition: • Application of the new hedge accounting requirements should be prospective. • Comparative figures would not be restated. • The previous hedge accounting relationships under IAS 39 would be regarded as continuing hedges and not involve a discontinuation/restart. • Further clarity is required regarding the treatment of previous hedge accounting relationships that do not qualify under the proposed model. • The proposed effective date should be for annual periods beginning on or after 1 January 2013 with earlier application permitted.

  21. IFRS / US GAAP Convergence

  22. Convergence • G-20 deadline for convergence of IFRS and US GAAP – June 2011 • IASB and FASB are working on a dozen major joint projects including: • Financial instruments • Revenue recognition • Leases • Statement of comprehensive income • Fair value measurement • In practice convergence remains a challenge • SEC issues a progress report in late October 2010 on incorporating IFRS into the US Financial Reporting System but drew no conclusions

  23. Classification and Measurement – IFRS vs US GAAP • Both IFRS 9 and the US GAAP ED propose a two category approach to classification • The two models are fundamentally different IFRS US GAAP FVTPL FVTPL Amortised cost FV - OCI • FASB received 2,800 comment letters and the issues raised may make the 30 June 2011 deadline for a standard very challenging

  24. Hedge Accounting – IFRS vs US GAAP • Both IFRS and US GAAP are making changes to the hedge accounting framework • There are significant differences in approach IFRS project US GAAP ED Full review of hedge accounting Limited Changes FVH changes FV - OCI All ineffectiveness in P&L All ineffectiveness in P&L Effectiveness testing changes Effectiveness testing changes Dedesignation unchanged Prohibits dedesignation

  25. Transition • FASB and IASB both asked for feedback on Transition and Effective Dates for key projects • Process is in response to concern at the volume of accounting change • Aim is a a effective plan for properly managing the transition to the new accounting standards

  26. Disclosure

  27. Changes to IFRS 7 disclosures • Late 2009 – reconciliation of Level 3 Movements • Purchases/Issues/Sales/Settlements/Transfers in/Transfers out • June 2010 – changes to the disclosures of measurement uncertainty for level 3 assets • Part of Fair Value Measurement Project • Recognition of correlation/interaction of unobservable inputs • October 2010 – disclosures on transfer of financial assets not derecognised • Part of Derecognition Project • All continuing involvement in assets at reporting date (irrespective of transfer date) • Excludes pass through transactions • Significant disclosures of nature, risks, carrying values of assets and cash flows of assets • Provides convergence with existing US disclosures for transfers under similar circumstances

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