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IAS 39 - Financial Instruments: Recognition and Measurement

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IAS 39
This Standard is effective for financial statements covering financial years beginning on or after 1 January 2001. Earlier application is permitted as of the beginning of a financial year that ends after 15 March 1999, the date of issuance of IAS 39. Retrospective application is not permitted. In October 2000, five limited revisions to IAS 39 and other related International Accounting Standards (IAS 27, IAS 28, IAS 31, and IAS 32) were approved to improve specific paragraphs and help ensure that the Standards are applied consistently. In March 2000, an approach to publishing implementation guidance on IAS 39 in the form of Questions and Answers was approved by the IASC. Subsequently, the IAS 39 Implementation Guidance Committee, which was established by the Board for that purpose, has published a series of Questions and Answers on IAS 39. The implementation guidance was not considered by the IASC and does not necessarily represent its views. The following SIC Interpretation relates to IAS 39: • SIC-33 Consolidation and Equity Method - Potential Voting Rights and Allocation of Ownership Interests. Introduction 1. This Standard (IAS 39) establishes principles for recognising, measuring, and disclosing information about financial assets and financial liabilities. This Standard supplements the disclosure provisions of IAS 32 Financial Instruments: Disclosure and Presentation. Background 2. In 1988, IASC began a project, jointly with the Canadian Institute of Chartered Accountants, to develop a comprehensive Standard on the recognition, measurement, and disclosure of financial instruments. IASC issued an exposure draft (E40) for comment in September 1991. Based on extensive input received, the proposals were reconsidered and a re-exposure draft (E48) was issued for comment in January 1994. 3. In view of the critical responses to E48, evolving practices in the use of financial instruments, and developing thinking by certain national accounting standard setters, IASC decided to divide the project into phases, starting with disclosure and financial statement presentation. 4. The first phase was completed in March 1995 when the IASC Board approved IAS 32 Financial Instruments: Disclosure and Presentation. IAS 32 deals with: (a) classification by issuers of financial instruments as liabilities or equity, and the classification of related interest, dividends, and gains and losses. This includes the separation of certain compound instruments into their liability and equity components; (b) offsetting of financial assets and financial liabilities; and (c) disclosure of information about financial instruments. 5. The second phase of the project is to consider further the issues of recognition, discontinuing recognition ('derecognition'), measurement, and hedge accounting. This Standard addresses those matters. 6. In July 1995, IASC reached agreement with the International Organization of Securities Commissions (IOSCO) on the content of a work programme to complete a core set of International Accounting Standards that could be endorsed by IOSCO for cross-border capital raising and listing purposes in all global markets. Those core standards include standards on recognition and measurement of financial instruments, off-balance sheet items, hedging, and investments. The disclosure standards of IAS 32, by themselves, do not fulfil IASC's commitment to IOSCO with respect to the minimum core standards. 7. In March 1997, IASC, jointly with the Canadian Institute of Chartered Accountants, published a comprehensive Discussion Paper, Accounting for Financial Assets and Financial Liabilities, and invited comments on the proposals therein. IASC held a series of special consultative meetings about those proposals with various national and international interest groups and in numerous countries. Those meetings and analysis of comment letters on the Discussion Paper confirm that IASC faces controversies and complexities in seeking a way forward. While some acceptance exists of the view put forward in the Discussion Paper-that measurement of all financial assets and liabilities at fair value is necessary to obtain consistency and relevance to users-application of that concept to some industries and to some kinds of financial assets and liabilities continues to present difficulty. Widespread unease is also evident about the prospect of including unrealised gains, particularly on long-term debt, in income as proposed in the Discussion Paper. Those difficulties will not be easily or quickly resolved. Further, while several national standard setters have undertaken projects to develop national standards on various aspects of recognition and measurement of financial instruments, no country has in place or proposed standards that are similar to the proposals in the Discussion Paper. 8. Completion of a single comprehensive International Accounting Standard on financial instruments based on the Discussion Paper for inclusion, before the end of 1998, in the core standards to be considered by IOSCO was not a realistic possibility. Nonetheless, the ability to use International Accounting Standards for investment and credit decisions and securities offerings and listings is urgent for both investors and business enterprises. Moreover, while financial instruments are widely held and used throughout the world, only a very few countries now have any national recognition and measurement standards at all for financial instruments. 9. At its meeting in November 1997, therefore, the IASC Board decided that: (a) IASC should join with national standard setters to develop an integrated and harmonised international accounting standard on financial instruments. That standard would build on the IASC Discussion Paper, existing and emerging national standards, and the best thinking and research on the subject world wide; and (b) at the same time, recognising the urgency of the matter, IASC should work to complete an interim international Standard on recognition and measurement of financial instruments in 1998. That solution, along with IAS 32 on disclosure and presentation of financial instruments and several other existing International Accounting Standards that address matters relating to financial instruments, will serve until the integrated comprehensive standard is completed. 10. A Joint Working Group comprising representatives of IASC and a number of national standard setters has begun work on the first of the foregoing two steps. This Standard is intended to accomplish the second step. IASC recognises that the proposals in its March 1997 Discussion Paper represent far-reaching changes from traditional accounting practices for financial instruments and that a number of difficult technical issues (which were discussed in the Discussion Paper) need to be resolved before standards fully reflecting those proposals could be put in place. IASC also believes that a programme of development work, field testing, preparation of guidance material, and education will be necessary to enable those principles to be effectively implemented. The IASC Board is committed to work with national standard setters throughout the world to achieve those goals within a reasonable time. In the interim, until those goals are achieved, this Standard will significantly improve the reporting of financial instruments. Exposure Draft E62 11. This Standard is based on Exposure Draft E62, which IASC issued for public comment on 17 June 1998. The formal comment deadline was 30 September 1998, but the Board announced that it would make every effort to consider comments received by 25 October, which it did. Constituents' views about the proposals in E62 were also solicited by a series of more than 20 seminars conducted around the world by the project manager and through published summaries of E62 in professional journals. To ensure the longest possible period for IASC constituents to review and develop their comments on E62, a copy of E62 was posted on IASC's Website for downloading. 12. Issues arising as a result of the comment process were considered by an IASC Steering Committee, which made recommendations to the Board, and then by the Board itself at meetings in November and December 1998. Greater Use of Fair Values for Financial Instruments 13. This Standard significantly increases the use of fair values in accounting for financial instruments, consistent with the direction the Board has given to the Joint Working Group to continue to study further the use of full fair value accounting for all financial assets and liabilities. This Standard changes current practice by requiring the use of fair values for: (a) nearly all derivative assets and derivative liabilities; (b) all debt securities, equity securities, and other financial assets held for trading; (c) all debt securities, equity securities, and other financial assets that are not held for trading but nonetheless are available for sale; (d) certain derivatives that are embedded in non-derivative instruments; (e) non-derivative financial instruments containing embedded derivative instruments that cannot be reliably separated from the non-derivative instrument; (f) non-derivative assets and liabilities that have fair value exposures being hedged by derivative instruments; (g) fixed maturity investments that the enterprise does not designate as 'held to maturity'; and (h) purchased loans and receivables that the enterprise does not designate as 'held to maturity'. 14. The three classes of financial assets that remain carried at cost under this Standard are loans and receivables originated by the enterprise, other fixed-maturity investments that the enterprise intends and is able to hold to maturity, and unquoted equity instruments whose fair value cannot be reliably measured (including derivatives that are linked to and must be settled by delivery of such unquoted equity instruments). The Board decided not to require fair value measurement for the loans, receivables, and other fixed maturity investments at this time for a number of reasons. One is the significance of the change from current practice that would be required in many jurisdictions. Another reason is the portfolio linkage of loans, receivables, and other fixed maturity investments, in many industries, to liabilities that, under this Standard, will be measured at their amortised original amount. Also, some question the relevance of fair values for fixed maturity investments intended to be held until maturity. The Joint Working Group is studying those matters. 15. Whether and how fair value can be reliably estimated for the unquoted equity instruments is also under study by the Joint Working Group. Most liabilities are not measured at fair value under this Standard-though all derivative liabilities (unless indexed to an unquoted equity instrument whose fair value cannot be reliably measured) and those held for trading are measured at fair value. Fair valuation of liabilities is the subject of several studies currently being undertaken by the Joint Working Group. Summary of this Standard 16. Under this Standard, all financial assets and financial liabilities should be recognised on the balance sheet, including all derivatives. They should initially be measured at cost, which is the fair value of the consideration given or received to acquire the financial asset or liability (plus certain hedging gains and losses). 17. Subsequent to initial recognition, all financial assets should be remeasured to fair value, except for the following, which should be carried at amortised cost subject to a test for impairment: (a) loans and receivables originated by the enterprise and not held for trading; (b) other fixed maturity investments, such as debt securities and mandatorily redeemable preferred shares, that the enterprise intends and is able to hold to maturity; and (c) financial assets whose fair value cannot be reliably measured (limited to some equity instruments with no quoted market price and some derivatives that are linked to and must be settled by delivery of such unquoted equity instruments). 18. After acquisition most financial liabilities should be measured at original recorded amount less principal repayments and amortisation. Only derivatives and liabilities held for trading should be remeasured to fair value. 19. For those financial assets and liabilities that are remeasured to fair value, an enterprise will have a single, enterprise-wide option to either: (a) recognise the entire adjustment in net profit or loss for the period; or (b) recognise in net profit or loss for the period only those changes in fair value relating to financial assets and liabilities held for trading, with the value changes for non-trading instruments reported in equity until the financial asset is sold, at which time the realised gain or loss is reported in net profit or loss. For this purpose, derivatives are always deemed held for trading unless they are part of a hedging relationship that qualifies for hedge accounting. 20. This Standard establishes conditions for determining when control over a financial asset or liability has been transferred to another party. For financial assets a transfer normally would be recognised if (a) the transferee has the right to sell or pledge the asset and (b) the transferor does not have the right to reacquire the transferred assets unless either the asset is readily obtainable in the market or the reacquisition price is fair value at the time of reacquisition. With respect to derecognition of liabilities, the debtor must be legally released from primary responsibility for the liability (or part thereof) either judicially or by the creditor. If part of a financial asset or liability is sold or extinguished, the carrying amount is split based on relative fair values. If fair values are not determinable, a cost recovery approach to profit recognition is taken. 21. Hedging, for accounting purposes, means designating a derivative or (in limited circumstances) a non-derivative financial instrument as an offset, in whole or in part, to the change in fair value or cash flows of a hedged item. A hedged item can be an asset, liability, firm commitment, or forecasted future transaction that is exposed to risk of change in value or changes in future cash flows. Hedge accounting recognises the offsetting effects on net profit or loss symmetrically. 22. Hedge accounting is permitted under this Standard in certain circumstances, provided that the hedging relationship is clearly defined, measurable, and actually effective. 23. This Standard applies to insurance enterprises except for rights and obligations under insurance contracts. This Standard applies to derivatives that are embedded in insurance contracts. A separate IASB project is under way on accounting for insurance contracts. Financial Instruments: Recognition and Measurement
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