Revisions to IAS 32, Financial Instruments: Disclosure and Presentation, and IAS 39, Financial Instruments: Recognition and Measurement

Date recorded:

The IASB considered amendments to IAS 39 and IAS 32 on financial instruments proposed in light of issues identified by audit firms, national standard-setters, regulators, the IGC, process, and IASB Staff. Topics addressed are not intended to introduce fundamental change to the standards. The Staff's proposals, presented by John Smith, partner in Deloitt & Touche and chairman of IGC, fall into the following categories:

  • Clarification of some definitions and scope, for example loan commitments, insurance contracts containing financial risks, commodity contracts or financial guaranties;
  • Changes to reduce complexity caused by the application of IAS 39 'mixed measurement model' by extending the use of fair value;
  • Clarification on how to bifurcate compound instruments under IAS 32;
  • Introduction into IAS 39 some of the IGC interpretations which will increase convergence between IAS 39 and US GAAP;
  • Clarification of how to classify derivatives on own shares: equity instruments or financial assets/liabilities?

Extending the use of fair value

The IASB tentatively agreed that it should permit measurement at fair value of certain financial assets or financial liabilities through designation at inception of financial instruments as part of the held for trading portfolio.

The purpose of this 'open' designation aims to ease natural hedge accounting of financial assets and liabilities that are managed on a portfolio basis. Under current IAS 39 rules trading assets are recorded in the held for trading portfolio and measured at fair value with changes recognised in the income statement but liabilities are not permitted to be marked to market due to the very restrictive definition of trading liabilities.

This option will also be applicable to originated loans under certain circumstances (for example, mortgage loans).

It will also permit the recognition in the income statement of changes in fair value of securities which do not meet the current criteria for classification in the trading portfolio but are held as a 'natural hedge' of embedded shares options contained, for example, in convertible debt. It also will enable embedded derivatives contained in a liability host contract not to be bifurcated by measuring the compound instrument at fair value with changes recorded in the income statement.

IASB tentatively agreed to eliminate the option to recognise changes in fair value of the AFS portfolio in the income statement. Therefore all fair value changes shall be recognised in equity. This amendment aims to converge with US GAAP.

The IASB tentatively agreed some changes regarding compound instruments for example, extending the exception regarding the bifurcation of embedded foreign currency derivative to situations including contracts written in a routinely used foreign currency in a country (for example US dollars in a highly inflationary environment).

The IASB also tentatively agreed that in applying split accounting for the liability and equity elements of an issued compound instrument, measurement should be made of the liability component first with any residual amount assigned to the equity element.

The IASB tentatively agreed that hedge accounting requirements should be amended as follows:

  • hedges of firm commitment should be classified as fair value hedges and not cash-flow hedges;
  • basis adjustment should be prohibited when a cash flow hedge of a forecasted transaction results in the recognition of an asset or a liability.
These proposals would converge with US GAAP.

Classification of derivatives of own shares as equity instruments or assets/liabilities

The Board had considerable discussion regarding the classification of derivative contracts on own shares:

  • where the contracts can only be settled by cash or are indexed to own share value, the Board tentatively agreed that these derivatives were assets/liabilities to be measured at fair value with changes in fair value recognise in the income statement;
  • where the contracts are required or permitted to be settled by physical delivery of own shares, such as a forward to sell, a purchase put or written call, the Board tentatively agreed that these derivatives should be classified as an equity instrument.

Disagreement existed where there was physical settlement of own shares received, for example, a forward to buy, a purchase call or a written put, to classify these derivative as a financial asset/liability. This specific issue may be discussed at a future Board meeting.

Loan losses

Considerable discussion took place regarding whether a loan loss provision should be recognised on a portfolio basis for a group of similar financial assets. The Board tentatively concluded, subject to development of further guidance to be discussed at the Board's January meeting, that large loans that had been individually reviewed and not identified as impaired could be included in groups of similar loans for an additional group assessment on a portfolio basis. The further guidance would be intended to clarify which factors are used to determine that a large loan should be included and timing of loss recognition.

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