Planned reform of financial instruments reporting (First of four parts)

KPMG CORNER - Armin M. Rau and Reinhard Klemmer () - November 23, 2010 - 12:00am

Introduction and background

Given the significance of financial instruments and the complexity of the associated accounting issues, Financial Instrument Accounting has been subject to much discussion. The global financial crisis brought an even sharper focus onto this debate.

For the International Accounting Standard Board (IASB), overhauling the financial reporting for financial instruments has had the highest priority throughout the last years. This is evidenced by the following changes: 2008: IAS 39 amendment on Reclassification; 2009: Issuance of IFRS 9 Financial Instruments (Part 1) and 2010: Planned Exposure Draft for Hedge Accounting. These are a result of the pressure on standard-setters to overhaul standards on financial instruments in light of a financial crisis they were said to have contributed to.

Given the far-reaching nature of IASB projects related to financial instrument accounting, many entities may need to undertake changes in systems used in internal and external reporting in order to comply with the new or proposed requirements. And these changes may have far-reaching effects: e.g. can investment companies invest in equities if they have to fair value the investment? It is likely that the planned accounting changes will have effects beyond finance and will affect the way business is conducted. For some, the impact may be negligible, but for others, the implications can be severe. For example, equity or income ratios may change or debt covenants may need to be revised.

Without a thorough assessment of the implications, the strategic action necessary to respond to the changes may be missed.

The objective of this article is to review and summarize the status of IASB’s projects to improve and simplify the financial reporting for financial instruments. It also aims togive a closer look at the IASB’s new financial reporting standard – IFRS 9 Financial Instruments. The following table gives an overview of the different projects, related to financial instruments accounting (source: IASB work plan):

(ED Exposure Draft; IFRS International Financial Reporting Standard)

Status of the financial instruments project – classification and measurement of financial assets and liabilities, impairment and hedging

The IASB is currently revising its accounting requirements for financial instruments. The objectives of the project include improving the decision-usefulness of financial statements for users by simplifying the classification and measurement requirements for financial instruments. This project aims to replace the existing standard IAS 39 Financial Instruments: Recognition and Measurement.

The IAS 39 replacement project, and in particular its timeline, is driven in part by the request for reform by the Group of Twenty (G20) and other constituents. Following the G20 summit in April 2009, the Leader’s Statement called on accounting standard-setters, including the IASB to work urgently with supervisors and regulators to improve standards and achieve a single set of high quality global accounting standards.

The IASB has adopted a phased approach in order to accelerate the replacement of IAS 39 and address concerns arising from the financial crises as quickly as possible while giving interested parties the opportunity to comment on the proposals in accordance with the IASB’s commitment to due process. The IASB’s project to replace IAS 39 is divided into three main phases:

• Classification and measurement of financial instruments. IFRS 9 Financial Instruments (the standard) on classification and measurement of financial assets was published on Nov. 12, 2009. On Oct. 28, 2010 the IASB issued requirements on the accounting for financial liabilities. These requirements will be added to IFRS 9 Financial Instruments and complete the classification and measurement phase of the IASB’s project to replace IAS 39;

• Impairment of financial assets (in progress - ED/2009/12 Financial Instruments: Amortized Cost and Impairment published on Nov. 5, 2009); and

• Hedge accounting (in progress) – an exposure draft (ED) is scheduled to be published in the fourth quarter 2010.

We would like to highlight that this approach allows immediate adoption of the current chapters of IFRS 9 on classification and measurement of financial assets without the need of restated comparatives. However early adoption will be a big step for any entity and it remains to be seen how many will choose this route of early adoption of parts of the standard.

The next milestones for the financial instruments project per IASB work plan are:

• By the end of the fourth quarter of 2010, the IASB expects to issue an exposure draft on hedge accounting.

• By the end of the second quarter of 2011, the IASB intend to issue a finalized financial instruments standards.

All changes will form part of the new IFRS 9 that will finally replace IAS 39. The entire package is expected to be completed by the end of Q2 2011 with mandatory adoption for years beginning after Dec. 31, 2012. In the meantime we will have both IAS 39 as well as IFRS 9 standards available.

To be continued

(Armin M. Rau is a senior manager for Audit and Reinhard Klemmer is a Seconded Partner from KPMG Germany to Manabat Sanagustin & Co., CPAs, a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email manila@kpmg.com or mquizon @kpmg.com)

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