Thursday, July 16, 2009

Simpler Accounting for Financial Instruments

Accounting for financial instruments will be simplified from previous methods according to the recent IAS 39 Exposure Draft.

A reduction in the number of different categories from 4 to 2 and the elimination of the messy ex guidance around embedded derivatives and some of the impairment requirements, significantly streamlines this area.

The classification is an attempt to replicate the business model in FI acconting. This means that where a loan portfolio is held to generate income from interest and principal cash flows, it will be measured on that basis and not on one that looks at fair value at a point in time.

The exposure draft draws on input from the March 2008 Discussion Paper Reducing Complexity in Reporting Financial Instruments and discussions of the Financial Crisis Advisory Group.

There are still some major issues to deal with. Amortised cost measurement will be available only for instruments with ’basic loan features’ which are managed on a ‘contractual yield basis’. The latter of these is hard to define for financial instruments that sit in the middle ground between those to be held for their entire term to generate income and those to be traded for profit in the short term; that is going to be a particular concern for those who invest surplus funds temporarily. The IASB itself has not yet concluded on this point and that it’s likely that additional guidance will be required.

There’s also the question of whether equivalent changes will be made to US GAAP. The FASB is currently reviewing the requirements of its own financial instruments standards, but is at a less advanced stage of its project than the IASB. Indications are that the FASB is in a different place to the IASB and their proposals may well require more instruments to be measured at fair value.

The IASB has indicated that if the FASB does reach different conclusions, then these will be exposed for comment to the IFRS constituency.

Old model:

Held for trading
Available for sale
Amortized cost
Held to maturity

New Model: