ias 32 & 39 new variances

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International Standards Alert

This Alert is issued by the IAS Desk for the use of staff of the firm and may not be distributed outside the firm. For

more information about this Alert please contact Terry Harding at phone +44 20 7694 8640, fax +44 20 7694 8429 or

email [email protected]

Issued: 12 January 2004 IS Alert: 2004/02

Title: Publication of amended IAS 32 and IAS 39

√ Accounting Issued by: IAS Advisory Services Status: Information

Auditing

Impact: The revised version of IAS 32 and IAS 39 apply for financial periods

beginning on or after 1 January 2005.

On December 17, 2003 revised IAS 32 and IAS 39 were published electronically on the IASB’s

website and these are expected to be published in hard copy by the end of January 2004. This alert

provides brief overview of key changes in revised IAS 32 and IAS 39 and is to be read together

with the revised standards themselves, which can be found on our internal website:

http://www.iasadvisory.kworld.kpmg.com/Home/default.asp. Further details of the requirements

in amended IAS 32 and IAS 39 will be summarised by IAS Advisory Services in a separate alert

and in an updated Financial Instruments Accounting publication in due course.

The IASB has made many improvements to IAS 32 and IAS 39 in the limited time available.

Additionally, the limited amendment to IAS 39 on macro hedging (Fair Value Hedge Accounting

for a Portfolio Hedge of an Interest Rate Risk) is still outstanding. The comment period ended on

November 14, 2003 and the final amendment is expected in the first quarter of 2004.

Highlights of amendments

Amended IAS 32 on Disclosure and Presentation of Financial Instruments

Definitions

� The definitions of a financial asset and a financial liability have been expanded to include

some contracts that will or may be settled in the entity’s own equity instruments and there is

new guidance on when derivative contracts on an entity’s own equity are liabilities. The

Standard requires a derivative with settlement options to be classified as a financial asset or a

financial liability unless all the settlement alternatives would result in equity classification.

Presentation

� The Standard has clarified that a financial instrument that gives the holder the right to put it

back to the issuer for cash or another financial asset (a “puttable instrument”) is a financial

liability. This is so even when the amount of cash or other financial assets is determined on

the basis of an index or other item that has the potential to increase or decrease, or when the

legal form of the puttable instrument gives the holder a right to a residual interest in the assets

of an issuer. The existence of an option for the holder to put the instrument back to the issuer

for cash or another financial asset means that the puttable instrument meets the definition of a

financial liability. For example, open-ended mutual funds, unit trusts, partnerships and some

co-operative entities may provide their unitholders or members with a right to redeem their

interests in the issuer at any time for cash equal to their proportionate share of the asset value

of the issuer. However, classification as a financial liability does not preclude the use of

descriptors such as “net asset value attributable to unitholders” and “change in net asset value

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IS Alert 2004/02

Consultation on amended IAS 32 and IAS 39

This Alert is issued by the IAS Desk for the use of staff of the firm and may not be distributed outside the firm.

attributable to unitholders” on the face of the financial statements of an entity that has no

equity capital or the use of additional disclosure to show that total members’ interests

comprise items such as reserves that meet the definition of equity and puttable instruments

that do not.

� The Standard has added that if an entity reacquires its own equity instruments, those

instruments (“treasury shares”) shall be deducted from equity. No gain or loss shall be

recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own

equity instruments. Such treasury shares may be acquired and held by the entity or by other

members of the consolidated group. Consideration paid or received shall be recognised

directly in equity.

� Amended IAS 32 requires all terms and conditions agreed between members of the group and

the holders of the instrument to be considered when determining if the group as a whole has

an obligation that would give rise to a financial liability. To the extent there is such an

obligation, the instrument or its component that is subject to the obligation, is a financial

liability in consolidated financial statements.

Disclosure

� The Standard has new disclosure requirements relating to fair value estimates derived through

valuation techniques, by requiring disclosure of:

i. the methods and significant assumptions applied in determining fair values of

financial assets and financial liabilities separately for significant classes of financial

assets and financial liabilities.

ii. whether fair values of financial assets and financial liabilities are determined directly,

in full or in part, by reference to published price quotations in an active market or are

estimated using a valuation technique.

iii. whether its financial statements include financial instruments measured at fair values

that are determined in full or in part using a valuation technique based on

assumptions that are not supported by observable market prices or rates. If changing

any such assumption to a reasonably possible alternative would result in a

significantly different fair value, the entity shall state this fact and disclose the effect

on the fair value of a range of reasonably possible alternative assumptions. For this

purpose, significance shall be judged with respect to profit or loss and total assets or

total liabilities.

iv. the total amount of the change in fair value estimated using a valuation technique that

was recognised in profit or loss during the period.

� Amended IAS 32 requires disclosure of the amount of the change in fair value that is not

attributable to changes in a benchmark interest rate for financial liabilities designated as at fair

value through profit or loss. This disclosure gives an indication of how much of the change in

fair value is caused by changes in the credit risk of the liability.

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IS Alert 2004/02



Amended IAS 39 on Recognition and Measurement of Financial Instruments

Scope

� The Standard excludes from its scope loan commitments that cannot be settled net and are not

classified at fair value through profit or loss. However, it requires that a commitment to

extend a loan at a below-market interest rate is initially recognised at fair value, and

subsequently measured at the higher of:

i. the amount determined under IAS 37; and

ii. the amount initially recognised, less where appropriate, cumulative

amortisation recognised in accordance with IAS 18.

Similarly, there is a requirement for financial guarantees to be initially recognised at fair value

and subsequently measured at the higher of the above listed two amounts. This is subject to

further changes during discussions on ED 5, Insurance Contracts.

Definitions

� Amended IAS 39 has revised the definition of loans and receivables category, by expanding

to include purchased loans and receivables (that are not quoted in an active market), as well as

originated ones. This amendment recognises the fact that originated and purchased loans are

often managed together. At the same time the definition is amended so that an instrument that

is quoted in an active market is not a loan or receivable.

� New guidance is given on the calculation of effective interest rates and the definition of the

effective interest rate is amended by requiring (for all instruments) the use of estimated cash

flows (for example prepayment estimates) while calculating effective yield. An exception is

made for those rare cases when it is not possible to estimate cash flows reliably, in which

cases the Standard requires the use of contractual cash flows over the contractual life of the

instrument. It further stipulates that when accounting for a change in estimates, entities need

to adjust the carrying amount of the instrument in the period of change with a corresponding

gain or loss recognised in profit or loss.

Recognition and Derecognition

� The derecognition rules have been substantially rewritten to clarify their application and the

Standard uses the concepts of control and of risks and rewards of ownership to determine

whether, and to what extent, a financial asset is derecognised. The continuing involvement

approach applies only if an entity retains some, but not substantially all, the risks and rewards

of ownership and also retains control. Additional guidance is provided on how to evaluate the

concepts of risks and rewards and of control for derecognition purposes.

� Amended IAS 39 clarifies when a part of larger financial asset should be considered for

derecognition. It requires a part of a larger financial asset to be considered for derecognition

if, and only if, the part is one of:

i. only specifically identified cash flows from a financial asset;

ii. only a fully proportionate (pro rata) share of the cash flows from a financial

asset; or

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IS Alert 2004/02



iii. only a fully proportionate (pro rata) share of specifically identified cash flows

from a financial asset.

In all other cases, the Standard requires the financial asset to be considered for

derecognition in its entirety.

� Amended IAS 39 gives an option to designate at inception any financial instrument as fair

value through profit or loss, which gives entities an opportunity to simplify the application of

IAS 39 by reducing the need for hedge accounting, eliminating the need to separate embedded

derivatives, and eliminating the problems that arise when matched positions of assets and

liabilities are not measured consistently. Additionally, it is clarified that the fair value of

liabilities with a demand feature, for example, demand deposits, is not less than the amount

payable on demand discounted from the first date that the amount could be required to be

paid.

� Amended IAS 39 permits entities, on transition, to designate a previously recognised financial

asset or financial liability as a financial asset or a financial liability at fair value through profit

or loss or available for sale. Additionally, a disclosure requirement has been added to IAS 32

to provide information about the fair value of the financial assets or financial liabilities

designated into each category and the classification and carrying amount in the previous

financial statements.

� The Standard requires prospective application of derecognition provisions, namely that

entities do not recognise those assets that were derecognised under the original Standard

before 1 January 2004, but permits retrospective application from a date of the entity’s

choosing.

Measurement

� The Standard contains an expanded guidance on the measurement of fair value. It requires

quoted prices in active markets to be used for determining fair value in preference to other

valuation techniques. There is also additional guidance that if a rate (rather than a price) is

quoted, these quoted rates are used as inputs into valuation techniques to determine the fair

value. It further clarifies that if an entity operates in more than one active market, the entity

uses the price at which a transaction would occur at the balance sheet date in the same

instrument (i.e. without modification or repackaging) in the most advantageous active market

to which the entity has immediate access.

� Amended IAS 39 simplifies the fair value measurement hierarchy in an inactive market so

that recent market transactions do not take precedence over a valuation technique. It states

that when there is not a price in an active market, a valuation technique is to be used,

including the use of recent arm’s length market transactions. The Standard also clarifies that

the best estimate of fair value at initial recognition of a financial instrument that is not quoted

in an active market is the transaction price, unless the fair value of the instrument is evidenced

by other observable market transactions or is based on a valuation technique whose variables

include only data from observable markets.

� The Standard states that impairment follows an “incurred loss” model rather than an

“expected loss” model and additional guidance is provided on measuring impairment.

Additionally, it is required for available-for-sale debt instruments that an impairment loss is to

be reversed through profit or loss when fair value increases and the increase can be

objectively related to an event occurring after the loss was recognised. Impairment losses

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IS Alert 2004/02



recognised on available-for-sale equity instruments cannot be reversed through profit or loss,

i.e. any subsequent increase in fair value is recognised in equity.

Hedging

� Amended IAS 39 requires that when a hedged forecast transaction actually occurs and results

in the recognition of a financial asset or a financial liability, the gain or loss deferred in equity

does not adjust the initial carrying amount of the asset or liability (i.e. “basis adjustment” is

prohibited), but remains in equity and is recognised in profit or loss consistently with the

recognition of gains and losses on the asset or liability. However, entities have the option to

use the “basis adjustment” method for hedges of forecast transactions that will result in the

recognition of a non-financial asset or non-financial liability. Under this method, deferred

gains and losses on the hedging instrument are treated as an adjustment to the cost of the

acquired asset or liability.

� The Standard requires hedges of firm commitments to be accounted for as fair value hedges,

rather than cash flow hedges. At the same time, it clarifies that a hedge of the foreign currency

risk of a firm commitment may be accounted for as either a fair value hedge or a cash flow

hedge.

Transitional provisions for first time adopters

The implementation process for entities adopting IFRS for the first time in 2005 will be complex

due to detailed transitional arrangements, the most significant of which are:

� Comparative information in the first year of adoption need not comply with IAS 32 and IAS

39 but may, in these respects, continue to be prepared in accordance with the entity’s previous

GAAP.

� Adjustments are made to the opening balance sheet (including retained earnings and other

reserves) at the beginning of the first IFRS reporting period, in order to measure all

recognised financial assets and financial liabilities in accordance with IAS 39.

� Entities can designate financial instruments as fair value through profit or loss or available-

for-sale on the date they first comply with IAS 32 and IAS 39.

� Existing hedges are eligible for hedge accounting in the restated opening balances if they

qualified for hedge accounting under previous GAAP. Hedges are eligible for hedge

accounting subsequently if they are properly designated and documented as such no later than

the beginning of the first IFRS reporting period, and otherwise qualify for hedge accounting

under IAS 39.

� Non-derivative financial assets and financial liabilities that were derecognised prior to 1

January 2004, remain derecognised, which gives a “safe harbour” for transactions that have

led to derecognition in the past. However, special purpose entities are required to be

consolidated if they are controlled under the criteria in SIC-12.

We intend to issue more detailed additional guidance on first-time adoption in due course.

ias 32 & 39 new variances

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