Financial Instruments, Issue 18, December 2013

26 Pages·2013·1.72 MB·English

Issue 18, December 2013
IFRS NEWSLETTER
FINANCIAL INSTRUMENTS
During 2013, signifcant
progress has been
made on the fnancial
instruments project.
We look forward to
the classifcation and
measurement and
impairment phases
being fnalised in
2014.
Chris Spall
The future of IFRS fnancial
KPMG’s global IFRS fnancial
instruments leader
instruments accounting
This edition of IFRS Newsletter: Financial Instruments highlights
the discussions of the IASB in December 2013 on the fnancial
instruments (IAS 39 replacement) project.
Highlights
Classifcation and measurement
l    The IASB and the FASB (the Boards) decided that the fair value option in IFRS 9 Financial
Instruments would also apply to fnancial assets that would otherwise be mandatorily
measured at fair value through other comprehensive income (FVOCI).
Impairment
l    The IASB reached tentative decisions on:
–    the measurement and presentation of expected credit losses on fnancial guarantee
contracts and loan commitments other than revolving credit facilities; and
–    transition requirements.
Fair value measurement
l    The IASB reached a tentative decision on applying the portfolio measurement exception when the
portfolio is fully made up of Level 1 fnancial instruments.
© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
REDELIBERATIONS WILL EXTEND INTO 2014
The story so far … What happened in December 2013?
Since November 2008, the IASB has been working to
At the December 2013 meeting, the IASB continued its
replace its fnancial instruments standard (IAS 39 Financial
redeliberations on the classifcation and measurement and
Instruments: Recognition and Measurement) with an
impairment phases of IFRS 9, and also discussed an issue
improved and simplifed standard. The IASB structured its
related to IFRS 13 Fair Value Measurement on measuring
project in three phases:
portfolios of fnancial instruments.
• Phase 1: Classifcation and measurement of fnancial
assets and fnancial liabilities In the classifcation and measurement project, the Boards
• Phase 2: Impairment methodology extended the scope of the fair value option to fnancial assets
• Phase 3: Hedge accounting. that would otherwise be mandatorily measured at FVOCI.
In December 2008, the FASB added a similar project to In the impairment project, the IASB discussed the
its agenda; however, the FASB has not followed the same measurement and presentation of expected credit losses on
phased approach as the IASB. fnancial guarantee contracts and loan commitments other
than revolving credit facilities. It also discussed transition
Classifcation and measurement requirements.
The IASB issued IFRS 9 Financial Instruments (2009) and Finally, the IASB considered the application of the portfolio
IFRS 9 (2010), which contain the requirements for the measurement exception in measuring fair value when the
classifcation and measurement of fnancial assets and portfolio is fully made up of Level 1 fnancial instruments. This
fnancial liabilities. In November 2012, the IASB issued
discussion forms part of its project to clarify:
an exposure draft (ED) on limited amendments to the
classifcation and measurement requirements of IFRS 9 • the unit of account for measuring the fair value of fnancial
(the C&M ED). assets that are investments in a subsidiary, joint venture or
The FASB issued a revised ED in February 2013 – the associate, and
proposed Accounting Standards Update, Financial • the interaction with the use of Level 1 inputs.
Instruments—Overall (Subtopic 825-10): Recognition and
Measurement of Financial Assets and Financial Liabilities This meeting concluded a busy 2013 for the IASB’s work on
(the proposed ASU). Separate and joint redeliberations the fnancial instruments project. Over the past few months,
by the Boards on the classifcation and measurement the IASB has made signifcant progress on its redeliberations
proposals are ongoing. The IASB plans to issue a fnal for the classifcation and measurement and impairment
standard by mid-2014. phases of IFRS 9. However, several items remain open for
discussion in 2014.
Impairment
The Boards were working jointly on a model for the
impairment of fnancial assets based on expected credit
losses, which would replace the current incurred loss model
in IAS 39. The Boards previously published their own differing
proposals in November 2009 (the IASB) and in May 2010
(the FASB), and published a joint supplementary document
on recognising impairment in open portfolios in January
2011. However, at the July 2012 joint meeting the FASB Contents
expressed concern about the direction of the joint project
and in December 2012 issued an ED of its own impairment
model, the current expected credit loss model. Meanwhile,
the IASB continued to develop separately its three-bucket
impairment model, and issued a new ED in March 2013 (the
impairment ED). Separate and joint redeliberations by the
Boards on the impairment proposals are ongoing, and the
IASB plans to issue a fnal standard by mid-2014.
Hedge accounting
The IASB has split the hedge accounting phase into two
parts: general hedging and macro hedging. The IASB
issued a new general hedging standard as part of IFRS 9
(2013) in November 2013, and is working towards issuing
a discussion paper (DP) on macro hedging in early 2014.
2 © 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
KEY DECISIONS MADE THIS MONTH
Classifcation and measurement
The fair value option in IFRS 9 would apply to fnancial assets that would otherwise be mandatorily
measured at FVOCI.
Impairment
• The IASB reached the following tentative decisions on the measurement and presentation
of expected credit losses on fnancial guarantee contracts and loan commitments other than
revolving credit facilities:
– the maximum period over which expected credit losses should be estimated is the
contractual period over which the entity is committed to provide credit;
– the same discount rate would be applied to the drawn and undrawn component of the
balance, unless the effective interest rate (EIR) cannot be determined, in which case the
discount rate should be determined as proposed in the impairment ED; and
– the provision for expected credit losses on the undrawn balance would be presented
together with the loss allowance on the drawn amount if an entity cannot separately identify
the expected credit losses associated with the undrawn balance.
• In respect of the transitional requirements the IASB tentatively:
– decided to retain the proposal to apply the fnal requirements retrospectively;
– confrmed that the ‘low credit risk exception’ may be used to identify fnancial instruments
for which there has been no signifcant increase in credit risk;
– clarifed that entities could approximate credit risk at initial recognition by using the best
available information that is available without undue cost or effort;
– confrmed that if an entity is not able to determine or approximate credit risk on initial
recognition it would measure the loss allowance based on the credit quality at each reporting
date until the asset is derecognised; and
– decided to provide, in the fnal standard, application guidance or examples to describe how
an entity would assess whether there has been a signifcant increase in credit risk where it
uses:
- the ‘more than 30 days past due rebuttable presumption’ if the entity identifes increases
in credit risk according to days past due; and
- a comparison of the credit risk at the date of transition to the initial maximum credit risk
(by product type and/or region).
Fair value measurement
• The IASB tentatively decided that the portfolio measurement exception can be applied to
portfolios made up of Level 1 fnancial instruments. The fair value should be measured on the
basis of the Level 1 prices for the individual instruments that comprise the net risk exposure.
© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 3
CLASSIFICATION AND MEASUREMENT
The fair value Fair value option extension
option in IFRS 9
What’s the issue?
would also apply
to fnancial IFRS 9 has two measurement categories – amortised cost and fair value through proft or loss
(FVTPL). The standard provides an irrevocable option to designate a fnancial asset at initial
assets that
recognition as measured at FVTPL if doing so eliminates or signifcantly reduces a measurement
would otherwise or recognition inconsistency – referred to as ‘an accounting mismatch’. This fair value option
be mandatorily applies only to fnancial assets that would otherwise be mandatorily measured at amortised cost.
measured at In the C&M ED, the IASB proposed:
FVOCI.
• introducing a third mandatory measurement category – FVOCI; and
• extending the fair value option in IFRS 9 so that it would also apply to fnancial assets that
would otherwise be mandatorily measured at FVOCI.
What did the staff recommend?
The staff noted that nearly all respondents agreed with the C&M ED’s proposal to extend the fair
value option to fnancial assets that would otherwise be mandatorily measured at FVOCI. Some
respondents advocated an unrestricted fair value option for assets that would otherwise be
measured at amortised cost or FVOCI.
The staff believed that if assets and liabilities have an economic relationship that gives rise to
an offsetting effect in their valuation, then accounting for them using the same measurement
attribute – i.e. FVTPL – may provide the most relevant information to users of fnancial
statements.
The staff recommended that the IASB confrm its proposals in the C&M ED.
In accordance with the existing fair value option in IFRS 9, the designation would need to be
performed at initial recognition and would be irrevocable.
What did the Boards decide?
The Boards agreed with the staff recommendation.
Next steps
At forthcoming meetings, the IASB will discuss the following topics, which will complete the
IASB’s redeliberations of the proposals in the C&M ED:
• the interaction between the accounting for fnancial assets and insurance contract liabilities
under the IASB’s insurance contracts project and various related issues;
• the presentation and disclosure requirements proposed in the C&M ED; and
• transition.
4 © 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
IMPAIRMENT
The IASB Financial guarantee contracts and loan commitments
reached tentative
What’s the issue?
decisions on the
measurement Under the impairment ED, an entity would recognise a provision for expected credit losses on
loan commitments and fnancial guarantees when it has a present contractual obligation to extend
and presentation
credit. The provision would be calculated using the estimated usage behaviour over a period during
of expected which a present legal obligation exists to extend credit.
credit losses
An entity would measure expected credit losses on these instruments using a discount rate
on fnancial that refects the current market assessment of the time value of money and the risks that are
guarantee specifc to the cash fows. By contrast, expected credit losses on drawn-down amounts would be
measured using a discount rate that is any reasonable rate between, and including, the risk-free
contracts
rate and the EIR1.
and loan
commitments In its November 2013 meeting, the IASB tentatively decided that, for revolving credit facilities:
other than • expected credit losses – including those on the undrawn facility – would be estimated for the
revolving credit period over which an entity is exposed to credit risk and future draw-downs cannot be avoided –
i.e. considering the behavioural life;
facilities.
• expected credit losses on the undrawn component of the facility would be discounted using the
same EIR, or an approximation thereof, as would be used to discount the drawn component; and
• the provision for expected credit losses on the undrawn component of the facility would be
presented together with the loss allowance on the drawn facility if an entity cannot separately
identify the expected credit losses associated with the undrawn facility.
In November, the Board requested that the staff perform further analysis to assess whether
the tentative decisions above should apply also to fnancial guarantee contracts and loan
commitments other than revolving credit facilities.
What did the staff recommend?
The staff recommended that:
• the Board reconfrm the proposals in the impairment ED that – for fnancial guarantee contracts
and loan commitments other than revolving credit facilities – the maximum period over which
expected credit losses should be estimated is the contractual period over which the entity is
committed to provide credit;
• the following November 2013 tentative decisions in respect of revolving credit facilities be
extended to all fnancial guarantee contracts and loan commitments:
– expected credit losses on the undrawn part of the balance would be discounted using the
same EIR, or an approximation thereof, as would be used to discount the drawn part, unless
the EIR cannot be determined, in which case the discount rate should be determined as
proposed in the impairment ED – i.e. it should refect the current market assessment of the
time value of money and the risks that are specifc to the cash fows; and
– the provision for expected credit losses on the undrawn balance would be presented
together with the loss allowance on the drawn amount if an entity cannot separately identify
the expected credit losses associated with the undrawn balance.
1 The impairment ED proposed that the discount rate to be used to determine expected credit losses on fnancial
assets could be any reasonable rate that is between, and including, the risk-free rate and the EIR. Subsequently,
at its October 2013 meeting, the IASB tentatively decided to require that the expected credit losses be
determined using the EIR or an approximation thereof.
© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 5
What did the IASB decide?
The Board agreed with the staff recommendations.
KPMG Insights
The IASB’s tentative decisions are a welcome development, as they would ease the operability
of the proposals by aligning them more closely with the way banks manage their credit risk.
Similarly, many constituents would support the tentative decision to present a provision for
expected credit losses on the undrawn balance together with the loss allowance on the drawn
amount if the expected credit losses associated with the undrawn balance cannot be identifed.
The IASB Transition requirements
provided
What’s the issue?
clarifcation on
Under the impairment ED, an entity would apply the proposed standard retrospectively in
the transition
accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. This
requirements.
would mean that the new requirements would be applied as if they had always been applied. The
impairment ED contained the following exemptions from full retrospective application.
• If determining the credit risk of an asset at initial recognition would require undue cost or effort,
then an entity would determine the loss allowance or provision only on the basis of whether
the fnancial asset has a low credit risk at each reporting date until that fnancial asset is
derecognised.
• The restatement of prior periods would not be required, but permitted if the information is
available without the use of hindsight.
The majority of respondents supported the transition proposals, arguing that they achieve a
balance between the cost and presentation of relevant information. However, some asked
the IASB to consider practical approaches to assess increases in credit risk at transition, if the
information is not available retrospectively. Others requested clarifcation of:
• the interaction between the more than 30 days past due rebuttable presumption and the
transition proposals; and
• whether delinquency and other relevant information can be considered in assessing signifcant
increases in credit risk at transition.
Some respondents asked for the same requirements to apply to frst-time adoption of IFRS.
Proposals for frst-time adoption will be considered by the IASB at a future meeting.
What did the staff recommend?
The staff recommended that some proposed transition requirements in the impairment ED
be clarifed.
They recommended that the Board reconfrm that:
• the fnal requirements would be applied retrospectively in accordance with IAS 8; and
• the following exemptions from full retrospective application would be available:
– the low credit risk exception to identify fnancial instruments for which the credit risk has not
increased signifcantly; and
6 © 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
– the more than 30 days past due rebuttable presumption if the entity identifes increases in
credit risk according to days past due.
The staff also recommended that the Board acknowledge that – consistent with its October 2013
tentative decision on the general principles of the impairment model – entities could assess
signifcant increases in credit risk by comparing:
• the maximum credit risk for a particular portfolio (by product type and/or region) of fnancial
instruments with similar credit risk – the ‘origination’ credit risk; with
• the credit risk of the fnancial instruments in that portfolio on transition.
For the remaining fnancial assets – for which an assessment of whether credit risk has increased
signifcantly would be required at transition – the staff recommended that the transition
requirements be clarifed to state that the loss allowance should be measured using lifetime
expected credit losses until the fnancial instrument is derecognised – unless an entity is able
to obtain or approximate the credit risk on initial recognition using the best information that is
available without undue cost or effort. The best available information is information that is:
• reasonably available and does not require the entity to undertake an exhaustive search; and
• relevant in determining or approximating the credit risk at initial recognition.
What did the IASB decide?
The Board agreed with the staff recommendations and confrmed the proposed requirements on
retrospective application and the low credit risk exception.
The Board also tentatively decided that an entity could approximate the credit risk at initial
recognition by considering the best information that is available without undue cost or effort. If an
entity is not able to determine or approximate the credit risk on initial recognition, then it would
measure the loss allowance based on the credit quality at each reporting date until the asset is
derecognised.
Furthermore, the IASB tentatively decided to provide, in the fnal standard, application guidance or
examples to describe how an entity would assess whether there has been a signifcant increase in
credit risk where it uses:
• the more than 30 days past due rebuttable presumption if the entity identifes increases in
credit risk according to days past due; and
• a comparison of the credit risk at the date of transition to the initial maximum credit risk (by
product type and/or region).
Next steps
At forthcoming meetings, the IASB intends to discuss the following topics:
• disclosures;
• frst-time adoption of IFRS; and
• any potential sweep issues.
The staff proposed summarising the model – including tentative decisions made during
deliberations. In addition, the staff will provide the IASB with an update on the FASB’s discussions.
© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 7
FAIR VALUE MEASUREMENT – PORTFOLIO
MEASUREMENT EXCEPTION
The portfolio What’s the issue?
measurement
The IASB has begun a project to clarify the unit of account for measuring the fair value of fnancial
exception can assets that are investments in a subsidiary, joint venture or associate – i.e. whether the unit of
be applied account should be:
to portfolios • the investment as a whole; accordingly, the valuation may include a premium – e.g. a control
made up of premium; or
Level 1 fnancial • the individual shares making up the investment; accordingly, the valuation could not include a
instruments. Fair premium, due to the size of the investment.
value should be The project would also clarify the interaction between the unit of account and the use of Level 1
measured on inputs.
the basis of the At its March 2013 meeting, the IASB tentatively decided that:
Level 1 prices for
• the unit of account for investments in subsidiaries, joint ventures or associates would be the
the individual investment as a whole; but
instruments that
• the fair value measurement of an investment composed of quoted fnancial instruments should
comprise the net be the product (P × Q) of the quoted price of the fnancial instrument (P) and the quantity (Q) of
risk exposure. instruments held.
The second decision was made on the basis that quoted prices in an active market provide the
most reliable evidence of fair value.
A similar issue arises in the interaction between the unit of account and the use of Level 1 prices
when applying the portfolio measurement exception to a group of fnancial instruments, when
permitted by IFRS 13 Fair Value Measurement. This issue was discussed at the December 2013
meeting.
What did the staff recommend?
The staff discussed the following questions in respect of the interaction between the application
of the portfolio measurement exception and the use of Level 1 inputs:
• whether the portfolio measurement exception can be applied to a portfolio fully made up of
Level 1 fnancial instruments; and;
• if so, whether the entity would:
– be required to measure the net risk exposure on the basis of the Level 1 prices for the
individual instruments that comprise the net risk exposure; or
– be allowed to consider the net risk exposure as a whole, and consequently adjust the fair
value measurement for any relevant premium or discounts that refect the size of the net
position.
The staff considered the following example in the discussion.
Entity A has a long position of 10,000 individual fnancial assets and a short position of 9,500
individual fnancial liabilities for which the market risks are substantially the same.
All fnancial instruments are categorised in Level 1 of the fair value hierarchy.
The entity applies the portfolio measurement exception for measuring its net position.
8 © 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.
Bid and ask prices and most representative exit prices within the bid-ask spread are as follows.
Bid Mid Ask
Prices 98 100 102
Most representative exit price 99 (for assets) 101 (for liabilities)
The most representative exit price for the net position of 500 fnancial assets is 45,000 – i.e. a
discount of 5,000 to the mid-market price.
The staff considered the following views on how to measure the fair value of the net position in
the portfolio.
View
A The portfolio Under this view, the guidance that restricts adjustment to
measurement Level 1 inputs would over-ride the application of the portfolio
exception measurement exception. The fair value of the net position in the
cannot be portfolio would be 30,500, calculated as follows.
applied to
Quantity held Most P × Q
portfolios
(Q) representative
made up of
quoted market
Level 1 fnancial
price (P)
instruments
Financial assets 10,000 99 990,000
Financial liabilities 9,500 101 (959,500)
Net long position 500 30,500
B The portfolio Under this view:
measurement
• the offsetting of assets and liabilities in the portfolio would be
exception can
measured using the same price within the bid-ask spread –
be applied
assuming that the market risks are substantially the same; and
to portfolios
made up of • the individual instruments comprising the net exposure would
Level 1 fnancial be measured using the Level 1 price – the most representative
instruments, price within the bid-ask spread – without further adjustments.
and the fair
The fair value of the net position in the portfolio would be 49,500,
value should be
calculated as follows.
measured on
the basis of the Quantity held Quoted market P × Q
Level 1 prices for (Q) price (P)
the individual
Financial assets 10,000 99 990,000
instruments that
2
comprise the net Financial liabilities 9,500 99 (940,500)
risk exposure
Net long position 500 49,500
2
2 The measurement of the fair value of the liabilities uses the same price as for the fnancial assets, because they
are fully offset by the assets.
© 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 9
View
C The unit of Under this view, the portfolio measurement exception can be
measurement applied to portfolios made up of Level 1 fnancial instruments, but, in
is the net risk contrast to View B, size is a characteristic that should be considered
exposure, and when measuring the fair value of the net position as a whole.
therefore the However, the portfolio measurement exception is intended to refect
size of the net circumstances where portfolio management maximises value.
risk exposure is Therefore, fair value under the portfolio exception should not be
a characteristic lower than if the portfolio measurement exception were not applied.
to be
The fair value of the net position in the portfolio would be 45,000
considered
– the fair value would equate to the valuation of the net position of
in measuring
500 fnancial assets (49,500 as in View B) adjusted by a discount for
the fair value.
size of 4,500. This is the most representative exit price for the net
However,
position as a whole when sold as a block, which is higher than the
the fair value
fair value when the portfolio measurement exception is not applied
should not be
– i.e. 30,500, as in View A.
lower than if
the portfolio
measurement
exception were
not applied
The staff recommended View B, for the following reasons.
• They believed that the IASB’s intention was not to restrict the application of the portfolio
measurement exception to portfolios exclusively made up of Level 2 and/or Level 3 fnancial
instruments.
3
• View B would be consistent with practice under IAS 39 , which the IASB did not intend to
change.
• IFRS 13 does not allow adjustments to Level 1 prices, except in specifc circumstances.
• Blockage factors are not permitted under IFRS 13.
• They believed that the measurement resulting from View B would represent the way in which
market participants would price the net risk exposure.
• View B would maximise value for the entity.
The staff also believed that View B results from direct application of IFRS 13, and that no
amendment to IFRS 13 is therefore needed to clarify this issue.
However, because the submission refects the existence of different views, the staff
recommended including a non-authoritative illustrative example as part of the forthcoming ED on
this project. Its aim would be to illustrate the use of the portfolio measurement exception for a
portfolio fully comprising Level 1 instruments.
33 Based on paragraph AG72 of IAS 39, which has been deleted by IFRS 13.
10 © 2013 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.