IAS 39

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IAS 39: Financial Instruments: Recognition and Measurement is a measure of instrument the International Accounting Standards Board(IASB).

It was adopted by the European Union in 2004.[1]

In 2005, the EU also introduced the fair value and hedging provision of the amended version of IAS 39.[2][3]

The EU version is set to be changed at the end of 2008 in response to the Financial crisis 2007.[4]

The comparative accounting measures in the United States are FAS 133 and FAS 157. The Financial Accounting Standards Board (FASB) released a 'FASB Staff Position' statement in October, 2008, in response to the financial crisis.[5]

IAS is being replaced with new standard IFRS 9.


Background on IAS 39

Remember the International Accounting Standards Board’s proposed revisions to IAS 39?

The organisation wants to update the accounting standard, which sets out how banks and other companies should value and categorise their financial instruments. It’s essentially another mark-to-market debate, and one which has provoked varying reactions among the financial industry - with many thinking it will increase the amount of stuff banks have to mark to market, a development many of them haven’t exactly been eager for.

However, there may still be some ‘good’ news for the banks, so to speak. Citi analysts Ronit Ghose and Stefan Nedialkov have an interesting take on the proposed changes to IAS 39, and are suggesting that the revisions may allow European banks to write-back billions in financial assets currently classified as available for sale, or AFS.

First, a bit of background, courtesy of the Citi analysts:

"...The credit crisis of 2007-09 brought with it a severe case of illiquidity. Price declines in a number of asset classes caused extreme risk aversion and low trading volumes. As a result, prices at the time incorporated not only expectations of deteriorating cashflows — but also a relatively large liquidity premium. Figure 2 shows one indicator of interbank liquidity, the TED spread (3 mo US LIBOR — 3 mo TSY Bill). It set a record of 450 basis points in October 2008 which correlated with a spike in securities writedowns in 4Q09 (Figure 3).

When banks had to mark-to-market their fair-value investments (trading and AFS), many were forced to use illiquid market prices. These, banks argued, led them to take write-downs which did not reflect underlying value but rather the presence of a sizeable liquidity premium. Banks’ capital bases eroded, new lending collapsed and banks had to raise capital. The lobbying for changes to the accounting standards thus came as no surprise.

At the peak of the crisis, in October 2008, the International Accounting Standards Board (IASB) allowed partial reclassification of AFS and Trading assets into the HTM category. The US Financial Standard Board (FASB) followed in March 2009 by limiting impairment charges on AFS debt instruments to the credit loss component, and provided additional guidance on measuring fair value in illiquid markets under US GAAP. The IASB has so far not changed the AFS impairment rules but has instead decided to overhaul the IAS 39 altogether...."

Second leg of IAS 39 published

A global accounting standard setter published on Thursday a second leg of proposals to replace its fair value rule that was criticised by policymakers for amplifying the credit crunch.

The latest draft from the International Accounting Standards Board (IASB), which sets accounting rules used in over 100 countries, including Europe, looks at how banks and other companies book losses on financial instruments such as loans and corporate bonds.

The change, likely to have a big impact when it takes effect, would let lenders book losses from bad loans more quickly.

Roughly two-thirds of the losses banks are grappling with come from loans turning sour.

Under current rules, losses can only be booked when they are incurred, such as in a default or bankruptcy.

This is to stop abuses such as companies building up hidden provisions for padding out poor earnings, known as the cookie jar effect.

The reform of IAS 39 rule follows calls from the G20 group of countries for a more forward-looking way of booking losses, sparking concerns among accountants that an independent standard setter is bowing to political pressure.

The G20 meeets in St Andrews, Scotland, on Friday and Saturday to review progress on pledges such as accounting changes and other financial reforms aimed at applying lessons from the credit crunch.

The IASB’s latest proposal will allow banks to take swift action on bad loans, a change policymakers hope will give them more time to make adequate provisions and lessen the need for the huge taxpayer-funded bailouts seen in the financial crisis.

“Therefore under the proposals, a provision against credit losses would be built up over the life of the financial asset. Extensive disclosure requirements would provide investors with an understanding of the loss estimates that an entity judges necessary,” the IASB said.

Accountants said the challenges of switching to a more forward-looking method of booking losses should not be underestimated and must not confuse investors.

“In exploring the case for change, it will be important to consider not only the practicalities of implementation but also whether the advantages of an approach based on expected cash flows outweigh the disadvantages,” said Nigel Sleigh-Johnson, head of financial reporting faculty at the Institute of Chartered Accountants (ICAEW) in England and Wales.

The IASB said it acknowledged the challenges and had therefore decided on a long consultation period, until end of June 2010. The change would not become mandatory until about 2013.

BREATHING SPACE The first leg of reform to IAS 39 is due to take effect shortly, in line with a G20 deadline that would allow banks and insurers to apply it to their 2009 annual reports.

It simplifies how banks and insurers classify which financial instruments must be valued at cost and which must be valued at the going market rate, known as marking to market.

Mandatory marking to market of some assets has forced banks to make huge writedowns in the credit crunch as some instruments like mortgage-backed securities sank in value or even became untradable.

The change that will soon take effect gives banks more breathing space than envisaged in the draft proposal published in July.

The IASB said it has listened carefully to stakeholders during its consultation. The latest amendments may partly deflect French criticism that the July proposal did not go far enough to help banks.

It will only cover the classificiation of instruments that are assets, leaving out liabilities until late 2010.

This delay should make a big difference for banks as many of the concerns in Europe centred on fears that more liabilities would have to be marked to market. Most valuations of liabilities are currently done at cost.

The final change also introduces more flexibility into how securitised assets are valued, with banks being allowed to take the underlying pool of assets more into account, thus allowing less senior tranches to be valued at cost.

Accountants said the change may have little immediate effect, however.

“Banks and insurers won’t be able to implement this for the end of 2009 even if it’s available. The number of organisations who might want to take advantage of it will be very small indeed,” said Michael Izza, chief executive of ICAEW.

The changes to internal systems and the risks for making mistakes this raises with only a few weeks left to compile the 2009 annual report will deter most firms, Izza said.

“It’s just putting another variable into a complex mix. It has to be audited as well,” he said.

The IASB is due to publish the third and final leg of its IAS 39 reform — covering hedge funds –at the turn of the year.

First phase of IAS 39 replacement complete

"The International Accounting Standards Board (IASB) issued today a new International Financial Reporting Standard (IFRS) on the classification and measurement of financial assets. Publication of the IFRS represents the completion of the first part of a three-part project to replace IAS 39 Financial Instruments: Recognition and Measurement with a new standard—IFRS 9 Financial Instruments. Proposals addressing the second part, the impairment methodology for financial assets were published for public comment at the beginning of November, while proposals on the third part, on hedge accounting, continue to be developed.

The new standard enhances the ability of investors and other users of financial information to understand the accounting of financial assets and reduces complexity – an objective endorsed by the Group of 20 leaders (G20) and other stakeholders internationally. IFRS 9 uses a single approach to determine whether a financial asset is measured at amortised cost or fair value, replacing the many different rules in IAS 39.

The approach in IFRS 9 is based on how an entity manages its financial instruments (its business model) and the contractual cash flow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the many different impairment methods in IAS 39. Thus IFRS 9 improves comparability and makes financial statements easier to understand for investors and other users.

The IASB has received broad support for its approach. This became evident during the unprecedented global scale of consultation and outreach activity it undertook in order to refine proposals contained within the exposure draft published in July 2009. Round-table discussions were held in Asia, Europe and the United States. Interactive webcasts, each attracting thousands of registered participants, have been held, often on a weekly basis. In addition, more than a hundred meetings have been held with interested parties around the world during the past four months."

On 23 September 2009 the staff of the IASB will present two identical webcasts on the project to replace IAS 39. The webcasts will be held at 11am and 5pm London time. The webcasts will address the following:

An overview of the feedback received on the Exposure Draft Financial Instruments:

Classification and Measurement, the Request for Information - impairment of financial assets and the Discussion Paper Credit Risk in Liability Measurement ; and the next steps in the project to replace IAS 39 taking into account the discussions at the September Board meeting

Both presentations will be followed by a Q&A session where registered participants can submit questions via the online facilities.

CFA Institute webinar on IAS 39

(Note the webinar specifically covers IAS 39 replacement)

The financial crisis has sharpened focus on accounting treatment of financial instruments. The accounting approach can influence investor appreciation of risk exposures associated with complex financial instruments. Treatment of the accounting for financial instruments also represents an area of potential differences between U.S. GAAP and IFRS, and investment professionals should understand the potential consequences of these toward the ongoing convergence of global financial reporting.

IASB representatives Patrick Finnegan, CFA, (IASB Board Member) and Sue Lloyd (IASB Senior Technical Adviser) give a presentation moderated by J.P. Morgan’s Dane Mott, CFA, in which the IASB’s approach to financial instrument accounting is reviewed.

This is a recording of a live event that occurred on Tuesday, 3 November 2009.

For more information about the project, please see the project webpage.

AASB 7 Financial Instruments: Disclosures

Source: AASB 7 Financial Instruments: Disclosures PKF Chartered Accountants and Business Advisors, June, 2008

The purpose of AASB 7 is to enable users of financial statements to assess “through the eyes of management”:

  • the significance of financial instruments to an entity; and
  • the nature & extent of risks arising from financial instruments on an entity.

Some of the significant new requirements of AASB 7 are:

  • no relief for parent entities;
  • comparatives to be disclosed; and
  • six significant disclosure additions with the introduction of the new standard:

Loans and receivables, and financial liabilities at fair value through profit and loss; Impairment provision reconciliation;

Hedge ineffectiveness; Fair value hedge adjustments;

Financial asset by class disclosure; and

Financial Instrument risk sensitivity analysis.

Some entities have experienced significant increases, up to 20 pages, in the level of disclosures required in their financial reports as a result of AASB 7, and significant increases in time associated with preparing notes such as financial asset past due analyses and sensitivity analyses associated with interest, market and other price risk.

Key issues to note:

The extent of disclosure will depend on the extent to which the entity uses financial instruments and has assumed risks. The risk of taking a ‘minimal disclosure’ approach is that external stakeholders may form a view that management has something to hide. Simply not disclosing information because it is not mandated by AASB7 is contrary to the requirement to disclose quantitative data based on internal information. Act now, AASB 7 is likely to result in significant increases in workload and disclosures for your financial report.


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