Replacement of IAS 39: Classification and Measurement

Date recorded:

This session was primarily an IASB session. The FASB will discuss measuring liabilities held to pay contractual cash flows together at a later separate FASB meeting.

Without much discussion the IASB agreed that financial liabilities held to pay contractual cash flows that have pain vanilla contractual cash flow characteristics should be measured at amortized costs unless the fair value option is elected.

Bifurcation methodology

The Board continued its discussion about the bifurcation methodology for the financial liabilities that are held to pay contractual cash flows and have non-vanilla contractual cash flows. (At the meeting on February 10, 2010 the IASB decided that such liabilities should be bifurcated into a host and the embedded features.)

The Board discussed two possible alternatives: maintaining the criteria of IAS 39 Financial Instruments: Recognition and Measurement or using bifurcation approach based on classification conditions in IFRS 9 Financial Instruments.

Although, many IASB members noted that IFRS 9 approach might be conceptually more sound (for instance, due to symmetry question), most of the IASB members agreed that retaining IAS 39 criteria to bifurcation would be less disruptive. Moreover, the IASB members liked the focus on the nature of the embedded feature rather than contractual approach.

The Board agreed that for most of the instruments the results of application of any of these bifurcation methods would be the same. However, one of the IASB members also expressed his doubts how operational would the IFRS 9 approach be for liabilities paying a market interest rate, but payment of the interest cannot be made unless the issuer is able to remain solvent immediately afterwards. He noted that valuation of compliance with prudential rules would be overly complex.

Finally, the IASB unanimously agreed to apply the IAS 39 bifurcation requirements for financial liabilities.

The FASB noted that the bifurcation methodology is very close with the FASB methodology for embedded derivatives.

Fair Value Option

The Board discussed the application of fair value option to financial liabilities.

The Board unanimously agreed to retain the fair value option for financial liabilities. As one of the IASB members noted, the fair value option was specifically designed for financial liabilities in the first place. In addition, the Board also confirmed all three eligibility conditions in IAS 39 for application of the fair value option (accounting mismatch, financial liabilities being managed at a fair value basis, financial liabilities containing one or more embedded features being accounted for in their entirety).

The Boards had a rather significant discussion on how to address the issue of the changes in own credit in the context of financial liabilities to which the fair value option is applied.

In effect, the Board discussed two alternatives of isolation of the effects of changes in own credit risk - either present the change in own credit risk a separate item directly in equity or in other comprehensive income.

The Board was relatively split in the discussion which solution was more appropriate. Some Board members preferred the presentation directly in equity as they believed that the change in credit risk represents a kind of a wealth transfer between creditors and owners. As one Board member noted, conceptually a debt instrument contains a put option on own equity and thus equity is the most appropriate place. On the other hand, other Board members stressed that nature of the changes in own credit risk does not represent a transaction between the entity and the owners and thus should not pre presented directly in equity but rather in a performance statement. They also cited potential problems with this approach - implication for company law in many jurisdictions (as this component might not be eligible to be 'equity' in some jurisdictions).

Finally, the Board narrowly approved the isolation of the changes in own credit risk in other comprehensive income.

Most of the Board members agreed that the mechanics of the isolation should include recognition of the total fair value change in profit or loss and separate recognition of the portion attributable in own credit risk in other comprehensive income with the offsetting entry to profit or loss. Some of the Board members questioned complexity of this mechanics, even though they acknowledged the benefits of enhanced transparency. The staff will provide additional analysis on the benefits of this approach to presentation.

The Board continued with a discussion whether to recycle the amount related to changes in own credit from other comprehensive income to profit or loss if the liability was derecognised before maturity. Even though some Board members noted that recycling might provide more useful information a narrow majority of the Board members agreed that the amounts should not be recycled.

Some Board members expressed their view that the approved model is overly complex and one of the objectives of the changes to financial instruments accounting was to reduce complexity.

One Board member said that isolation of the changes in own credit is not appropriate for all liabilities to which fair value option can be applied. According to this Board member, the presentation of the change in own credit in other comprehensive income is appropriate only for fair value option applied to a financial liability containing one or more embedded features being accounted for in its entirety. In the other two cases (accounting mismatch, management on a fair value basis), such separate presentation might exacerbate the mismatches that the fair value option was designed to minimise and would thus defeat the purpose of fair value option.

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