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ED on financial instruments classification and measurement

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14 Jul 2009

The IASB has published an exposure draft (ED) on 'Financial Instruments: Classification and Measurement' as the first part of its three-phase project to replace IAS 39 'Financial Instruments: Recognition and Measurement'.

The Board decided to address classification and measurement of financial assets and financial liabilities first because they form the foundation of a standard on reporting financial instruments. Moreover, many of the concerns about IAS 39 that have been expressed during the financial crisis relate to its classification and measurement requirements.

The IASB plans to finalise the classification and measurement proposals in time for non-mandatory application in 2009 year-end financial statements.

The other two phases of the IAS 39 project are addressing Impairment and provisioning and hedge accounting. Additionally, the Board's project on derecognition of financial instrument will also result in amendments to IAS 39.

The IASB plans to complete the replacement of IAS 39 during 2010, although mandatory application will not be before January 2012.

Comments on the ED on Classification and Measurement are due by 14 September 2009. Click for IASB press release (PDF 102k).

Here is an overview of the ED:

Overview of Exposure Draft on Classification and Measurement of Financial Instruments
  • Primary classification and measurement categories for financial instruments.  A financial asset or financial liability would be measured at amortised cost if two conditions are met:
    • The instrument has basic loan features. A debt instrument has basic loan features if the return to the holder is a fixed amount, fixed over the life, variable over the life due to changes in a single referenced quoted or observable interest rate, or a combination of a fixed and variable return (such as LIBOR plus a fixed spread).
    • The instrument is managed on a contractual yield basis. While this condition is similar to the 'held to maturity' condition in the existing IAS 39, there are no 'tainting provisions' comparable to those in IAS 39 that would prohibit an entity from measuring a financial asset at amortised cost if it has recently sold other financial assets measured at amortised cost before maturity. However, special disclosures would be required for derecognition of a financial asset or financial liability measured at amortised cost.
    A financial asset or financial liability that does not meet both conditions would be measured at fair value. This would include all investments in equity instruments (and derivatives on those equity instruments) – including those that do not have a quoted market price in an active market. That is, there would be no 'measurement reliability' exception for equity instruments such as now exists in IAS 39.
  • Existing IAS 39 classifications of 'held to maturity' and 'available for sale' These classifications would be eliminated. Note, however, that the ED proposes an accounting policy choice to measure some investments in equity instruments at fair value through other comprehensive income (see below).
  • Some investments in equity instruments could be measured at fair value through other comprehensive income The ED proposes to permit an entity, on initial recognition of investments in equity instruments that are not held for trading but are held for purposes other than realising direct investment gains, to make an irrevocable election to present changes in the fair value of those investments in other comprehensive income. Dividends on such investments would also be presented in other comprehensive income. There would be no transfers from other comprehensive income to profit or loss ('recycling') and hence no impairment requirements.
  • Embedded derivatives The ED proposes that a hybrid contract with a host that is within the scope of the proposed IFRS (that is, it is a financial host) must be classified in its entirety in accordance with the proposed classification approach. This would eliminate the existing IAS 39 requirements to account separately for an embedded derivative and the host contract.
  • Investments in contractually subordinated interests (tranches) The ED proposes to apply the classification criteria to such investments by requiring that any tranche that provides credit protection to other tranches on the basis of any possible outcome (rather than a probability-weighted outcome) must be measured at fair value because provision of such credit protection is a form of leverage and not a basic loan feature.
  • Fair value option retained The ED would retain IAS 39's 'fair value option' by which an entity may elect at initial recognition to measure any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an 'accounting mismatch').
  • Classification is determined at initial recognition The ED would prohibit subsequent reclassification of financial assets and financial liabilities between the amortised cost and fair value categories.
  • Effective date The current plan (subject to review) is that the new requirements would not be mandatorily effective before January 2012, but early application would be permitted.
  • Transition Generally retrospective, with some exceptions.
The IASB will host two live Web presentations to introduce the ED on Wednesday 15 July 2009, one at 9:30am London time and the second at 3:00pm London time.

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