IASB proposes amendments to IAS 32 and IAS 39

  • IASB Exposure Draft (original) Image

22 Jun 2002

The IASB has issued an Exposure Draft proposing significant amendments to the two International Accounting Standards dealing with accounting for financial instruments, IAS 32 and IAS 39.

Comments are due by 14 October 2002.

The principal changes would:

  • Allow an entity to designate any financial instrument (including its own outstanding debt) irrevocably at initial recognition as an instrument that is measured at fair value with changes in fair value recognised in profit or loss
  • Require that all fair value changes for available-for-sale financial instruments be recognised as a separate component of equity, with 'recycling' through net profit or loss when the financial asset is sold or liability discharged (the option to recognise such fair value changes immediately in net profit or loss would be eliminated)
  • Add guidance for recognising impairment losses in groups of loans or other financial assets
  • Prohibit reversal of impairment losses previously recognised for available-for-sale financial assets
  • Treat hedges of firm commitments as fair value hedges rather than as cash flow hedges
  • Prohibit 'basis adjustment' for hedges of forecasted transactions, though continue to require basis adjustment for fair value hedges
  • Establish the principle of 'no continuing involvement' for deciding whether a financial asset should be derecognised.  An entity would not be permitted to derecognise assets to the extent that it could, or could be required to, reacquire control of the transferred asset, or could receive or be required to pay compensation based on the performance of the asset.

Click for IASB Press Release (PDF 35k).

Key proposals in the Exposure Draft

Summary of the key proposals in the exposure draft to amend IAS 32 and IAS 39


  • Conform the scopes of IAS 32 and IAS 39.
  • Extend scope of IAS 39 to cover financial guarantee contracts.

Extending the Use of Fair Value


  • 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 would be 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.
  • The option to measure at fair value will also be applicable to originated loans under certain circumstances (for example, mortgage loans) by designating them as available-for-sale (AFS).
  • Financial assets that do not have a fixed maturity will be eligible for classification as a loan or receivable originated by the entity.
  • Eliminate the option to recognise changes in fair value of the AFS portfolio in the income statement. Therefore all fair value changes for AFS financial assets will be recognised in equity. This amendment aims to converge with US GAAP.

Hedge Accounting


  • Hedges of firm commitments would be classified as fair value hedges, which is the US treatment in SFAS 133, and not as cash flow hedges, which is the current IAS 39 treatment.
  • Basis adjustment (adjusting the carrying amount of the acquired asset or liability) will be prohibited when a cash flow hedge of a forecasted transaction results in the recognition of an asset or a liability. This proposal would converge with US GAAP. Instead the hedging gain or loss will remain in equity but will be amortised to income at the same time as the related asset or liability affects income. Basis adjustment would be continued for fair value hedges.

Classification of Financial Instruments as Equity Instruments or Liabilities


  • Regarding derivatives indexed to an entity's own shares, the proposals are as follows:


    Physical settlementNet settlement - cash or sharesIssuer choice - past practice of gross settlementIssuer choice - past practice of net settlementCounterparty choice
    Forward buy Liability Derivative Asset/ Liability Liability Derivative Asset/ Liability Liability
    Forward sell Equity Derivative Asset/ Liability Equity Derivative Asset/ Liability Derivative Asset/ Liability
    Purchased call Equity Derivative Asset/ Liability Equity Derivative Asset/ Liability Derivative Asset/ Liability
    Written call Equity Derivative Asset/ Liability Equity Derivative Asset/ Liability Derivative Asset/ Liability
    Purchased put Equity Derivative Asset/ Liability Equity Derivative Asset/ Liability Derivative Asset/ Liability
    Written put Liability Derivative Asset/ Liability Liability Derivative Asset/ Liability Liability
    Total return swap Derivative Asset/ Liability


  • The basic principle is to ask if there is a residual interest. If no, then classification as a liability is appropriate; if yes, then it is necessary to ask if there is a possibility of cash settlement. If yes, then classification as a liability is appropriate; if no, then classification as equity is appropriate.
  • For physical settlement, or for issuer choice where historically physical settlement has been used, the embedded derivative should be ignored. In other words, the embedded option should be thought of as a change in terms rather than as a forward.
  • The guidance in proposed final SIC D34 should be incorporated into IAS 32. Thus, an instrument is a liability if the holder has the right to put the instrument back to the issuer for cash or another financial asset, the amount of which is determined based on an index or other item that has the potential to increase and decrease.
  • An entity that has no equity (such as an open-ended mutual fund or unit trust) may present a liability to repay a proportionate share of the net asset value of the entity as 'net asset value attributable to unit holders' on the face of the balance sheet and the change in the value of the liability as 'change in net asset value attributable to unit holders' (a performance measure) on the face of the income statement.
  • Regarding measurement of compound instruments, IAS 32 would be clarified to require measurement of the liability element of a compound liability/equity instrument first and then to assign the residual value to the equity. This is both the easier way of measuring the components and is consistent with the definition of equity as a residual.
  • Delete the example in IAS 32.22 about preferred shares that have a contractually accelerating dividend yield so high that it is likely to compel redemption. 'Economic compulsion' should not be the basis for classification.
  • Regarding derivatives indexed to the price of an entity's own shares:
    • If the derivative requires net cash or net share settlement, or gives the counterparty a choice of net cash or net share settlement, is a derivative asset or liability (not an equity instrument).
    • If the derivative gives the issuing entity a right to require net cash or net share settlement is a derivative asset or liability (not an equity instrument) unless the issuer has an established history of settling such contracts through gross physical settlement.
    • Changes in the fair value of a derivative that is fully indexed to the price of an entity's own shares and that will result in the receipt or delivery of a fixed number of own shares in exchange for a fixed amount of cash should not be recognised in the financial statements.
    • When a derivative involves an obligation to pay cash in exchange for receiving own shares, the entity recognises a liability for the share redemption amount.
  • SIC 5, Classification of Financial Instruments - Contingent Settlement Provisions, will be incorporated into IAS 32.
  • Make certain changes regarding compound instruments, for example, extending the exception regarding splitting out 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).

Financial Guarantee Contracts


  • Initially measure financial guarantee contracts at fair value
  • Subsequently, remeasure them at the amount the enterprise would have to pay to settle the obligation at balance sheet date or to transfer it to a third party.

Contracts to Purchase or Sell Commodities or Other Non-Financial Assets


  • These must be accounted for as derivatives if the entity has a practice of taking delivery of the non-financial and then reselling it to generate a short-term profit.



  • The derecognition provisions of IAS 39 will clarified by establishing as the guiding principle a 'continuing involvement' approach that disallows derecognition to the extent to which the transferor has continuing involvement in an asset or a portion of an asset it has transferred.
  • A transferor has a continuing involvement when:
    • It could, or could be required to, reacquire control of the transferred asset (for example, if the financial asset can be called back by the transferor, the transfer does not qualify for derecognition to the extent of the asset that is subject to the call option); or
    • Compensation based on the performance of the transferred asset will be paid (for example, if the transferor provides a guarantee, derecognition is precluded up to the amount of the guarantee).
  • No exceptions are made to the general principle. The following existing exceptions in IAS 39 are eliminated:
    • The notion that the transferor must not retain substantially all of the risk and returns of certain assets in order for any portion of those assets to qualify for derecognition; and
    • The transferee 'right to sell or repledge' condition for derecognition.
  • Guidance will be provided dealing with pass-through arrangements. When the transferor continues to collect cash flows from the transferred asset, additional conditions must be met for a transfer to qualify for derecognition, including:
    • The transferor has no obligation to pay cash flows to the transferee unless it collects equivalent cash flows from the transferred asset;
    • The transferor cannot use the transferred asset for its benefit; and
    • The transferor is obligated to remit on a timely basis any cash flows it collects on behalf of the transferee.
  • Continuing involvement would exist through call and put options, forwards, guarantees, subordinations, and other means. There was agreement that this model significantly simplifies the accounting for derecognition. This approach has been labelled a 'sticky fingers' approach in that it is much easier to recognise an asset or liability than to derecognise it. While it simplifies the approach currently in IAS 39, it is not a move to conform to US GAAP. It will make IAS 39 operable in the short term.
  • If a transferor retains a portion of a financial asset and that portion is subordinated for any losses that might occur in the portion that was sold, then the transferor has continuing involvement in the portion sold.
  • If financial assets are sold through an SPE, generally they will be consolidated in accordance with SIC 12, Consolidation - Special Purpose Entities. On an ongoing basis, the investor in the SPE needs to consider whether they have maintained continuing involvement.
  • Repurchases and security lending will not result in derecognition, and the IGC interpretations regarding right of first refusal, wash sales and clean up calls are to be incorporated into the ED. This does not change the principle requirements for the derecognition of financial liabilities and the current IGC interpretations are to be incorporated.
  • If a financial asset that is measured at fair value is transferred, and the transfer does not qualify for derecognition because of a retained call or written put option, the measurement of the asset's fair value should be limited by the exercise price of the option.
  • Asset and liability balances relating to a transfer that does not qualify for derecognition may not be offset in the balance sheet.

Loan Losses


  • A financial asset that is individually identified as impaired should not be included in a group of assets that are collectively assessed for impairment.
  • An asset that has been individually assessed for impairment and found not to be individually impaired should be included in a collective assessment of impairment. The occurrence of an event or a combination of events should not be a precondition for including an asset in a group of assets that are collectively evaluated for impairment.
  • Assets should be grouped by similar credit risk characteristics that are indicative of the debtors' ability to
  • pay all amounts due according to the contractual terms.
  • Contractual cash flows and historical loss experience should provide the basis for estimating expected cash flow.
  • Historical loss rates should be adjusted based on relevant observable data that reflect current economic conditions.
  • The methodology for measuring impairment should ensure that an impairment loss is not recognised immediately on initial recognition. In measuring impairment in groups of assets, estimated cash flows (contractual principal and interest payments adjusted for estimated credit losses) should be discounted using an effective interest rate that equates the present value of the estimated cash flows with the initial net carrying amount of those assets.

Impairment of Investments in Debt and Equity Carried at Fair Value


  • If impairment is recognised for investments in debt and equity instruments classified as available for sale, that impairment will be regarded as permanent. No reversal of the impairment will be allowed. This treatment conforms to the current US practice. All temporary fair value changes must be reported as a component of equity.
  • Debt and equity investments should be treated in the same way.

Disclosure - Valuation Techniques


  • The Board discussed valuation techniques, which is a major issue following the collapse of Enron. The Board agreed that more guidance is needed on fair value but was unsure of what else to include as the objective was felt to be very clear. Additional disclosure regarding the valuation technique was decided to be the best solution. Accordingly, disclosure will be required of:
    • Extent to which valuations are based on assumptions that are not supported by observable market prices
    • Sensitivity of those estimated fair value to changes in valuation assumptions
    • Changes in estimated fair values recognised based on those valuations

Other Disclosure


  • Eliminate IAS 32.94, which encourages disclosures about changes in fair value that have been recognised in net profit or loss and average balance sheets.
  • An issuer of a compound instrument with multiple embedded derivative features (such as a callable convertible bond) should disclose information about the existence of those features and the effective yield of the instrument.



  • The old paragraph 39.172(h) will be replaced. If a financial instrument qualified for derecognition under the old rules but does not qualify for derecognition under the new rules, the financial instrument must be re-recognised on the balance sheet.



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