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IAS 32 & 39 New Variances
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kpmg
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
Page 2
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
Consultation on amended IAS 32 and IAS 39
Page 3
This Alert is issued by the IAS Desk for the use of staff of the firm and may not be distributed outside the firm.
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
Consultation on amended IAS 32 and IAS 39
Page 4
This Alert is issued by the IAS Desk for the use of staff of the firm and may not be distributed outside the firm.
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
Consultation on amended IAS 32 and IAS 39
Page 5
This Alert is issued by the IAS Desk for the use of staff of the firm and may not be distributed outside the firm.
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.