International Accounting Standard 39

RUQUIA SHAH ISLAMIA UNIVERSITY BAHAWALPUR (DEP OF COMMERCE)

IAS 39 Financial Instruments: Recognition and

Measurement

The objective of this Standard is to establish principles for recognizing

and measuring financial assets, financial liabilities and some contracts to

buy or sell non-financial items at their fair value.

IAS 39 amends IAS 32 particularly with instructions related to so-called

"derivatives". These are, e.g. swaps, option contracts, futures, forwards or

complex, hybrid financial instruments which frequently serve for

speculation purposes as issued at 1 January 2012.

This extract has been prepared by IFRS Foundation staff and has not been approved by the IASB

because the impairment phase of the IFRS 9 project has not yet been completed.

In IFRS 9 most of the requirements for financial liabilities were carried forward unchanged from

IAS 39. However, some changes were made to the fair value option for financial liabilities to

address the issue of own credit risk (principles of Recognition and Measurement over a period of

time in IFRS 9 Financial Instruments in November 2009 and de-recognition of financial assets

and liabilities were added to IFRS 9 in October 2010).

In result, parts of IAS 39 are being superseded and will become obsolete for annual periods

beginning on or after 1 January 2013, earlier application is permitted in 2010. The remaining

requirements of IAS 39 continue in effect until superseded by future installments of IFRS 9. The

Board expects to replace IAS 39 in its entirety.

Initial Recognition

All financial assets and financial liabilities are recognized on the balance

sheet, including all derivatives as assets and liabilities in their statement of

financial position.

IAS 39 provides the following examples of how to apply the principles

Unconditional receivables and payables are recognized as assets or

liabilities when the entity becomes a party to the contract and, as a

consequence, has a legal right to receive or a legal obligation to pay cash.

Assets to be acquired and liabilities to be incurred as a result of a firm commitment to

purchase or sell goods or services are generally not recognized until at least one of the

parties has performed under the agreement. For example, an entity that receives a firm

order does not generally recognize an asset (and the entity that places the order does not

recognize a liability) at the time of the commitment but, rather, delays recognition until

the ordered goods or services have been shipped, delivered or rendered. If a firm

Financial instrument

Any contract that gives

rise to both a financial

asset of one entity and a

financial liability or

equity instrument of

another entity.

Financial asset Any asset that is cash, or a contractual right to receive cash or another financial asset

from another entity or to exchange financial instruments with another entity, or an equity instrument of another Entity.

commitment to buy or sell non-financial items is within the scope of this Standard its net

fair value is recognized as an asset or liability on the commitment date. In addition, if a

previously unrecognized firm commitment is designated as a hedged item in a fair value

hedge, any change in the net fair value attributable to the hedged risk is recognized as an

asset or liability after the inception of the hedge

A forward contract that is within the scope of this Standard is recognized as an asset or a

liability on the commitment date, rather than on the date on which settlement takes place.

When an entity becomes a party to a forward contract, the fair values of the right and

obligation are often equal, so that the net fair value of the forward is zero. If the net fair

value of the right and obligation is not zero, the contract is recognized as an asset or

liability.

Option contracts that are within the scope of this Standard are recognized as assets or

liabilities when the holder or writer becomes a party to the contract.

Planned future transactions, no matter how likely, are not assets and liabilities because

the entity has not become a party to a contract.

Initial Measurement

All financial instruments are measured initially at fair value, directly attributable transaction

costs are added to or deducted from the carrying value of those financial instruments that are not

subsequently measured at fair value

through profit or loss.

Fair value

“The amount for which an asset could be exchanged or a liability settled, between

knowledgeable, willing parties in an arm’s length transaction” (IAS 39 paragraph 9)

Directly attributable transaction costs

Incremental costs that is directly attributable to the acquisition, issue or disposal of a

financial asset or financial liability.

An enterprise will recognize normal purchases of securities in the market place either at trade

date or settlement date. If settlement date accounting is used, IAS 39 requires recognition of

certain value changes between trade and settlement dates so that the income statement effects are

the same for all enterprises.

Subsequent measurement of financial assets

For the purpose of measuring a financial asset after initial recognition, this Standard classifies

financial assets into the following four categories

Financial assets at fair value through profit or loss;

Held-to-maturity investments;

Loans and receivables; and

Available-for-sale financial assets.

Subsequent Measurement of Financial Liabilities

After initial recognition, an entity shall measure all financial liabilities at amortized cost using

the effective interest method, except for:

Financial liabilities at fair value through profit or loss. Such liabilities, including derivatives

that are liabilities, shall be measured at fair value except for a derivative liability that is

linked to and must be settled by delivery of an unquoted equity instrument whose fair value

cannot be reliably measured, which shall be measured at cost.

Financial liabilities that arise when a transfer of a financial asset does not qualify for de

recognition or when the continuing involvement approach applies.

financial guarantee contracts after initial recognition, an issuer of such a contract shall

measure it at the higher of:

o the amount determined in accordance with IAS 37; and

o The amount initially recognized less, when appropriate, cumulative amortization

recognized in accordance with IAS 18.

Commitments to provide a loan at a below-market interest rate. After initial recognition, an

issuer of such a commitment shall measure it at the higher of:

o The amount determined in accordance with IAS 37; and

o The amount initially recognized less, when appropriate, cumulative amortization

recognized in accordance with IAS 18.

Reclassification

Financial instruments at fair value through profit or loss o Derivative financial instruments may not be reclassified out of this

category while it is held or issued.

o Any financial instrument designated into this category on initial

recognition may not be reclassified out of this category.

o May reclassify instruments that would have met the definition of

loans and receivables out of this category to loans and receivables

if the entity has the intention and ability to hold for the foreseeable future or until

maturity. Any gain or loss already recognized in profit or loss is not reversed. The fair

value on date of reclassification becomes the new cost or amortized cost.

o May reclassify instruments to held to maturity or available for sale in rare

circumstances.

Derivative financial

Instrument Instrument that creates

rights and obligations with the effect of transferring one or more of the financial risks inherent in an underlying primary financial instrument.

o May not reclassify a financial instrument into the fair value through profit or loss

category after initial recognition.

Held to maturity instruments o If no longer appropriate to classify investment as held to maturity, reclassify as

available for sale and re measure to fair value

o Difference between carrying amount and fair value recognized in equity

o Prohibited from classifying any instruments as HTM in the current and following two

financial years.

Available for sale instruments o May reclassify instruments that would have met the definition of loans and

receivables out of this category to loans and receivables if the entity has the intention

and ability to hold for the foreseeable future or until maturity.

Financial instruments measured at cost as unable to reliably measure fair

value o If a reliable fair value measure becomes available for which a fair value measure was

previously not available, the instrument is required to be measured at fair value.

o Difference between carrying amount and fair value recognized in equity for available

for sale instruments.

o Difference between carrying amount and fair value recognized in profit or loss for

financial instruments measured at fair value through profit or loss.

Fair value measurement is no longer reliably measureable o If a financial instrument currently carried at fair value subsequently has to be carried

at cost or amortized cost because fair value is no longer reliably measurable, the fair

value carrying amount at that date becomes the new cost or deemed cost.

o Prior gain/loss on financial asset with no fixed maturity recognized in equity remains

in equity until the financial asset is derecognized at which time it is released to profit

or loss.

IMPAIRMENT

Assess at each reporting date whether there is objective evidence that a financial asset (group of

financial assets) is impaired. If there is evidence of impairment then following procedures should

be considered:

Financial assets at amortized cost o Amount of the loss is measured as the difference between the asset’s carrying amount

and the present value of estimated future cash flows discounted using the asset’s

original effective interest rate. Future credit losses that have not been incurred are

excluded.

o The carrying amount of the asset is reduced either directly or through the use of an

allowance account.

o The impairment loss is recognized in profit or loss.

o Reversals of impairment are recognized in profit or loss. Reversals cannot result in a

carrying amount that exceeds what the amortized cost would have been had no

impairment been recognized.

Financial assets at cost o Amount of the loss is measured as the difference between the asset’s carrying amount

and the present value of estimated future cash flows discounted at the current market

rate of return for a similar financial asset.

Available for sale financial assets o When a decline in the fair value of the asset has been recognized directly in OCI and

there is objective evidence that the asset is impaired, the cumulative loss recognized

directly in OCI is removed from OCI and recognized in profit or loss.

o Subsequent reversals of impairment losses recognized in profit or loss on equity

instruments are recognized in OCI, not profit or loss

o Subsequent reversals of impairment losses recognized in profit or loss on debt

instruments are recognized in profit or loss.

Computation of Impairment of Asset

DERECOGNITION

De recognition of a Financial Asset An enterprise should derecognize a financial asset when, and only when, the enterprise loses

control of the asset. An enterprise loses such control if it realizes the rights to benefits specified

in the contract, the rights expire, or the enterprise surrenders those rights. If this derecognition

criteria is not satisfied, the transferor accounts for the transaction as a collateralized borrowing.

In that case, the transferor's right to reacquire the asset isn't a derivative.

If the position of either the transferor or transferee indicates that the transferor has retained

control, the transferor shouldn't remove the asset from its balance sheet.

A transferor has not lost control if, for example:

the transferor has the right to reacquire the transferred asset unless either

o The asset is readily obtainable or

o The reacquisition price is fair value at the time of reacquisition;

The transferor is both entitled and obligated to repurchase or redeem the transferred asset on

terms that effectively provide the transferee with a lender's return on the assets received in

exchange for the transferred asset. A lender's return is one that isn't materially different from

that which could be obtained on a loan to the transferor that is fully secured by the

transferred asset; or

The asset transferred isn't readily obtainable and the transferor has retained substantially all

of the risks and returns of ownership through a total return swap with the transferee or has

retained substantially all of the risks of ownership through an unconditional put option on the

transferred asset held by the transferee.

De recognition of a financial liability A financial liability (or part of it) is extinguished when the debtor either:

Discharges the liability (or part of it) by paying the creditor, normally with cash, other

financial assets, goods or services; or

Is legally released from primary responsibility for the liability (or part of it) either by

process of law or by the creditor. (If the debtor has given a guarantee this condition may

still be met.)

Hedge Accounting

Hedge accounting may be applied if, and only if, all the following criteria are

met:

o At the inception of the hedge there is formal designation and

documentation of the hedging relationship and the entity’s risk

management objective and strategy for undertaking the hedge.

o The hedge is expected to be highly effective (80 – 125 % effective) in

achieving offsetting changes in fair value or cash flows attributable to

the hedged risk, consistently with the originally documented risk management strategy

for that particular hedging relationship.

o For cash flow hedges, a forecast transaction that is the subject of the hedge must be

highly probable and must present an exposure to variations in cash flows that could

ultimately affect profit or loss.

o The effectiveness of the hedge can be reliably measured, i.e., the fair value or cash flows

of the hedged item that are attributable to the hedged risk and the fair value of the

hedging instrument can be reliably measured.

o The hedge is assessed on an ongoing basis and determined actually to have been highly

effective throughout the financial reporting periods for which the hedge was designated.

Hedging

Action taken with the object of avoiding or minimizing the

possible adverse effects of movements in exchange rates or market prices.

CASH FLOW HEDGE

Definition

A hedge of the exposure to variability in cash flows that

o Is attributable to a particular risk associated with a recognized asset or liability (such

as all or some future interest payments on variable rate debt) or a highly probable

forecast transaction and

o Could affect profit or loss

The portion of the gain or loss on the hedging instrument that is determined to be an effective

hedge is recognized in OCI; and the ineffective portion of the gain or loss on the hedging

instrument is recognized in profit or loss.

If the hedge results in the recognition of a financial asset or a financial liability, the

associated gains or losses that were recognized in OCI are reclassified from equity to profit

or loss as a reclassification adjustment in the same period(s) during which the asset acquired

or liability assumed affects profit or loss.

If the hedge results in the recognition of a non-financial asset or a nonfinancial liability, then

the entity has an accounting policy election of either:

o Reclassifying the associated gains and losses that were recognized in OCI to profit or

loss as a reclassification adjustment in the same period or periods during which the

asset acquired or liability assumed affects profit or loss (such as in the periods that

depreciation expense or cost of sales is recognized.

o Removing the associated gains and losses that were recognized in OCI and including

them in the initial cost or other carrying amount of the asset or liability.

Cash flow hedge accounting is discontinued prospectively if:

o The hedging instrument expires or is sold, terminated or exercised (net amount

recognized in OCI remains in equity until forecast transaction occurs and is then

treated as described above).

o The hedge no longer meets the criteria set out in the above block (net amount

recognized in OCI remains in equity until forecast transaction occurs and is then

treated as described above).

o The forecast transaction is no longer expected to occur (net amount recognized in

OCI is transferred immediately to profit and loss as a reclassification adjustment).

o The entity revokes the designation (net amount recognized in OCI remains in equity

until forecast transaction occurs and is then treated as described above).

FAIR VALUE HEDGE

Definition A hedge of the exposure to changes in fair value of a recognized asset or liability or an

unrecognized firm commitment, or an identified portion of such an asset, liability or firm

commitment, that is attributable to a particular risk and could affect profit or loss

Gain/loss from re measuring the hedging instrument at fair value or the foreign

currency component of its carrying amount is recognized in profit or loss

Gain/loss on the hedged item attributable to the hedged risk adjusts the carrying

amount of the hedged item and is recognized in profit or loss

Fair value hedge accounting is discontinued prospectively if:

o The hedging instrument expires or is sold, terminated or exercised.

o The hedge no longer meets the criteria set out above

o The entity revokes the designation.

Where hedge accounting is discontinued, adjustments to the carrying amount of

A hedged financial asset for which the effective interest rate is used are amortized to profit or

loss. The adjustment is based on a recalculated effective interest rate at the date amortization

begins.

HEDGE OF A NET INVESTMENT IN A FOREIGN OPERATION

Hedges of a net investment in a foreign operation, including a hedge of a monetary item that is

accounted for as part of the net investment, are accounted for similarly to cash flow hedges:

The portion of the gain or loss on the hedging instrument that is determined to be an effective

hedge is recognized in equity; and

The ineffective portion is recognized in profit or loss.

The gain or loss on the hedging instrument relating to the effective portion of the hedge that has

been recognized in OCI is reclassified from equity to profit or loss as a reclassification.

DESIGNATION OF NON-FINANCIAL ITEMS AS HEDGED ITEMS

If the hedged item is a non-financial asset or nonfinancial liability, it is designated as a hedged

item, either:

For foreign currency risks

In its entirety for all risks, because of the difficulty of isolating and measuring the appropriate

portion of the cash flows or fair value changes attributable to specific risks other than foreign

currency risks.

NOVATION OF DERIVATIVES

Hedge accounting continues for negated derivatives so long as:

The novation is a consequence of laws or regulations (or the introduction of laws or

regulations)

The parties to the hedging instrument agree that one or more clearing counterparties replace

their original counterparty to become the new counterparty of each party.

Any changes to the hedging instrument are limited only to those that are necessary to effect

such a replacement of the counterparty (including changes in the collateral requirements,

rights to offset receivable and payable balances, charges levied.)