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The future of IFRS nancial


instruments accounting
This edition of IFRS Newsletter: Financial Instruments highlights
the discussions and tentative decisions of the IASB in June 2012
on the nancial instruments (IAS 39 replacement) project.
Highlights
Classication and measurement
l
The IASB and the FASB (the Boards) re-afrmed their previous decisions that the fair value
through other comprehensive income (FVOCI) category is only available for nancial assets
that:
pass the contractual cash ow characteristics assessment; and
are managed within a business model whose objective is both to hold nancial assets to
collect contractual cash ows and to sell nancial assets.
l
The IASB decided to extend the fair value option (FVO) for nancial assets that meet the
accounting mismatch eligibility criterion as included in IFRS 9 Financial Instruments to nancial
assets in the FVOCI measurement category.
l
The FASB decided to retain the FVO eligibility criteria related to management of a group of nancial
assets and liabilities on a net exposure basis that was included in its tentative classication and
measurement model; this is different from the accounting mismatch and managed on a fair value
basis FVO eligibility criteria included in IFRS9.
Impairment and hedge accounting
l
The Boards did not discuss impairment or hedge accounting.
In June, the IASB decided to
extend the existing fair value
option for nancial assets in
IFRS 9 to nancial assets in
the new FVOCI measurement
category. This would be based
on the accounting mismatch
criterion that is used today
under IFRS. However, the
FASB chose not to adopt
the same criterion into its
tentative model.


Chris Spall,
KPMGs global IFRS Financial
Instruments deputy leader
KPMG International Standards
Group
IFRS NEWSLETTER
FINANCIAL INSTRUMENTS
Issue 3, June 2012
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2
Since November 2008, the IASB has been working to replace its nancial instruments standard
(IAS39) with an improved and simplied standard. The IASB structured its project in three phases:
Phase 1: Classication and measurement of nancial assets and nancial liabilities
Phase 2: Impairment methodology
Phase 3: Hedge accounting
In December 2008, the FASB added a similar project to its agenda; however, the FASB has not
followed the same phased approach as the IASB.
The IASB issued IFRS 9 (2009) and IFRS 9 (2010), which contain the requirements for the
classication and measurement of nancial assets and nancial liabilities. Those standards have
an effective date of 1 January 2015. The IASB is currently considering limited changes to the
classication and measurement requirements of IFRS 9 to address application questions, and
to provide an opportunity for the Boards to reduce key differences between their models. At the
May 2012 meeting, the IASB decided to add an FVOCI category for some investments in debt
instruments.
The Boards are also working jointly on a three-bucket model for the impairment of nancial assets
based on expected credit losses, which will 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.
The IASB has split the hedge accounting phase into two parts: general hedging and macro
hedging. It is close to issuing a review draft of a general hedging standard and is working towards
issuing a discussion paper on macro hedging towards the end of 2012.
At the June 2012 meeting, the Boards met jointly to continue their deliberations on classication
and measurement. The Boards did not discuss impairment or hedge accounting at this meeting.
The Boards reafrmed their previous decisions that the FVOCI measurement category should only
be available for nancial assets that:
pass the contractual cash ow characteristics assessment; and
are managed within a business model whose objective is both to hold the nancial assets to
collect contractual cash ows and to sell the nancial assets.
The IASB also decided to extend the accounting mismatch FVO eligibility criterion as stated in
IFRS 9 to nancial assets in the FVOCI measurement category.
The FASB decided not to adopt the same accounting mismatch criterion. However, it did decide
to extend the fair value option to certain hybrid nancial liabilities in a manner similar to IFRS 9.
What happened
in June?
IASB AND FASB DIFFER ON FAIR VALUE OPTION
ELIGIBILITY CONDITIONS
The story so far...
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What happened in June?
At the June 2012 meeting, the IASB continued its joint deliberations with the FASB. At this
meeting, the topics discussed were:
the scope of the FVOCI measurement category for debt instruments; and
the fair value option.
(See Appendix A for a summary of the IASBs decisions to date on its limited reconsideration of
IFRS 9.)
Scope of the FVOCI measurement category
Previously, the Boards had tentatively decided that:
nancial assets that do not pass the contractual cash ow characteristics assessment would
not be eligible for a measurement category other than FVTPL; and
an eligible debt instrument would qualify for FVOCI classication if it was held within a business
model whose objective is both to hold nancial assets to collect contractual cash ows and to
sell nancial assets.
In this meeting, the Boards discussed and conrmed the scope of the FVOCI measurement category.
What did the staff recommend?
Although the scope has been implicit in the decisions previously taken, the staff recommended
that the Boards reafrm their decision that the FVOCI category should only be available for
nancial assets that:
pass the contractual cash ow characteristics assessment (i.e. the contractual terms give rise
on specied dates to cash ows that are solely principal and interest); and
are managed within the relevant business model.
1
The staff believed that if the use of the FVOCI category were expanded to nancial assets that do
not pass the contractual cash ow characteristics assessment, then this would involve a major
overhaul of both IFRS 9 and the FASBs model. Such a major overhaul would be inconsistent with
the limited scope and objectives of the Boards redeliberations on classication and measurement.
It would also give rise to unwanted implications that could, for example, result in gains and losses
on stand-alone or embedded derivatives being presented in other comprehensive income the
staff did not believe that such an outcome would provide useful information for users of nancial
statements. The staff noted that the FVOCI classication would result in prot or loss information
based on amortised cost measurement. They argued that this attribute was suited only to
instruments whose cash ows are solely principal and interest, and not to nancial assets with
volatile or leveraged cash ows.
What did the Boards decide?
The Boards tentatively agreed with the staff recommendation i.e. that the FVOCI category
should only be available for nancial assets that:
pass the contractual cash ow characteristics assessment; and
are managed within the relevant business model.
1 IFRS 9 allows an election for equity instruments that are not held for trading to be measured at FVOCI. This
election is outside the scope of the Boards discussion.
The FVOCI
measurement
category is only
available for
nancial assets
that pass the
contractual
cash ow
characteristics
assessment and
are managed
within the
relevant business
model.
CLASSIFICATION AND MEASUREMENT
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Fair value option
The discussion of the FVO was divided into FASB-only and IASB-only sessions. The FASB-only
session considered whether the FASB wished to incorporate the FVO requirements in IFRS 9 into
its own tentative model. Because the FASB chose not to adopt the IFRS 9 requirements related
to nancial assets, the IASB alone discussed whether those requirements should be extended to
nancial assets in the FVOCI measurement category.
Under IFRS 9, an entity may, at initial recognition, irrevocably designate a nancial asset or
a nancial liability as measured at FVTPL if doing so eliminates or signicantly reduces a
measurement or recognition inconsistency (sometimes referred to as an accounting mismatch)
that would otherwise arise from measuring assets or liabilities, or recognising the gains and losses
on them, on different bases. Also, an entity may similarly designate a nancial liability as measured
at FVTPL if the liability is either:
part of a group that is managed, and whose performance is evaluated, on a fair value basis in
accordance with a documented strategy, with information about the group being provided on
that basis to the entitys key management personnel; or
a hybrid nancial liability that contains an embedded derivative unless:
(a) the embedded derivative does not signicantly modify the cash ows that would otherwise
be required by the contract; or
(b) it is clear with little or no analysis that, when a similar hybrid instrument is rst considered,
separation of the embedded derivative is prohibited.
What did the FASB decide?
The FASB decided not to adopt IFRS 9s accounting mismatch or managed on a fair value basis
eligibility criteria for the fair value option. Instead, it decided to retain the FVO eligibility criteria in
its tentative classication and measurement model; this would allow an entity to apply the FVO to
a group of nancial assets and liabilities when it both:
manages the net exposure relating to those nancial assets and nancial liabilities (which may
be derivative instruments); and
provides information on that basis to the reporting entitys management.
However, the FASB decided to extend the fair value option to certain hybrid nancial liabilities in a
manner similar to IFRS 9.
What did the staff recommend to the IASB?
IFRS 9 discusses accounting mismatches for nancial assets only in the context of the two
measurement categories amortised cost and FVTPL that are currently available in the standard.
In May 2012, the IASB tentatively decided to introduce a FVOCI measurement category into
IFRS9. Accounting mismatches can similarly arise as a result of measuring a nancial asset at
FVOCI. Two possible scenarios are as follows.
Scenario How an accounting mismatch arises
An asset is measured at FVOCI and a liability
is measured at FVTPL
An accounting mismatch arises because
some of the gains or losses on the asset
would be recognised in OCI, whereas all of
the gains and losses on the liability would be
recognised in prot or loss.
The accounting
mismatch
eligibility criterion
for the fair value
option included in
IFRS 9 is extended
to nancial assets
in the FVOCI
measurement
category.
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Scenario How an accounting mismatch arises
An asset is measured at FVOCI and a liability
is measured at amortised cost
An accounting mismatch arises because the
instruments are measured in the statement of
nancial position on different bases.
Moreover, although both instruments would
have an amortised cost prole in prot or loss,
other fair value gains or losses on the asset
would be recognised in OCI.
The staff believed that if the eligibility condition for designating a nancial asset as at FVTPL to
avoid an accounting mismatch was available for nancial assets measured at FVOCI, then both the
asset and the liability in the above scenarios could be measured at FVTPL
2
, thus providing more
relevant information.
Therefore, the staff recommended that the IASB extend the accounting mismatch eligibility
criterion as stated in IFRS 9 to nancial assets in the FVOCI measurement category.
What did the IASB decide?
The IASB tentatively agreed with the staff recommendation i.e. that the current eligibility
condition (the accounting mismatch condition) in IFRS 9 for designating nancial assets under
the fair value option would be extended to nancial assets in the FVOCI measurement category.
In other words, a nancial asset that would otherwise be measured at FVOCI may be designated
on initial recognition as measured at FVTPL if doing so eliminates or signicantly reduces an
accounting mismatch.
Next steps
At future meetings on the classication and measurement of nancial instruments, the IASB will
consider any further inter-related issues, including the accounting mechanics of reclassications,
transition, disclosures and other sweep issues. Some of these discussions may need to be held
jointly with the FASB, while others may be separate. The Boards will also consider what further
changes, if any, they would like to make to their respective models.
The IASB expects to issue an exposure draft on changes to IFRS 9 in the fourth quarter of 2012.
2 Under the second scenario, the entity would also have to designate the nancial liability under the FVO.
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The current work plan anticipates signicant progress in 2012, which will be necessary to maintain
an effective date for IFRS9 of 1January 2015.
Revised
standard?
2012 2010 2009
Asset and
liability
offsetting
Impairment
Classification
&
measurement
Hedge
accounting
?
Source: IASB work plan projected targets as at 14 June 2012
Standard
on assets:
IFRS 9 (2009)
Supplementary
document
Exposure
draft
(Q4)
Exposure
draft
2011
Effective
1/1/2015
date
Effective
dates 1/1/2013
and 1/1/2014
G
e
n
e
r
a
l
M
a
c
r
o
Exposure
draft
Standard
on liabilities:
IFRS 9 (2010)
Discussion
paper
(H2)
Amendments
to IFRS 7 and
IAS 32
Final
standard?
Deferral of
effective date
Exposure
draft limited
revisions
(Q4)
Review draft
(Q2)
Final standard
(H2)
1 2 3
4 5
6
7
Final
standard?
Exposure
draft?
Effective
date?
Our suite of publications considers the different aspects of the work plan, and provides a
comparison to IAS 39 where relevant.
KPMG publications
1
First Impressions: IFRS 9 Financial Instruments (December 2009)
For KPMGs most recent and comprehensive views on IFRS 9, refer to Insights into
IFRS: Chapter 7A Financial instruments: IFRS 9.
2
First Impressions: Additions to IFRS 9 Financial Instruments (December 2010)
For KPMGs most recent and comprehensive views on IFRS 9, refer to Insights into
IFRS: Chapter 7A Financial instruments: IFRS 9.
3
In the Headlines: Amendments to IFRS 9 Mandatory effective date of IFRS 9 deferred to
1 January 2015 (December 2011)
4
New on the Horizon: ED/2009/12 Financial Instruments: Amortised Cost and Impairment
(November 2009)
5
New on the Horizon: Impairment of nancial assets measured in an open portfolio
(February 2011)
6 New on the Horizon: Hedge Accounting (January 2011)
7
First Impressions: Offsetting nancial assets and nancial liabilities (February 2012)
For more information on the project see our website.
The IASBs website and the FASBs website contain summaries of the Boards meetings, meeting
materials, project summaries and status updates.
PROJECT MILESTONES AND TIMELINE FOR
COMPLETION
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Note: Decisions made in June 2012 are shaded.
What did the
IASB discuss?
What did the IASB tentatively decide? Is there an identied change to IFRS 9?
If yes, then what?
Business model
assessment for
amortised cost
classication for
nancial assets
An eligible debt instrument (i.e. a nancial
asset that passes the contractual cash ows
characteristics assessment) would qualify for
amortised cost classication if it was held within
a business model whose objective was to hold
the assets to collect contractual cash ows.
(April2012)
To clarify the primary objective of hold to collect,
the Boards will provide additional implementation
guidance on the types of business activities and
the frequency and nature of sales that would
prohibit nancial assets from qualifying for
amortised cost measurement.
Business model
assessment
for fair value
through other
comprehensive
income (FVOCI)
classication for
nancial assets
An eligible debt instrument would qualify for
FVOCI classication if it was held within a
business model whose objective is both to hold
nancial assets to collect contractual cash ows
and to sell nancial assets. (May 2012)
Eligible debt instruments that do not meet
the business model assessment for FVOCI or
amortised cost would be classied at FVTPL
i.e. FVTPL is the residual business model.
(May2012)
Yes there is currently no FVOCI measurement
category for eligible debt instruments in IFRS 9.
The Boards have also tentatively decided to
provide application guidance on the types of
business activities that would qualify for the
FVOCI business model.
Scope of the
FVOCI category
for debt
instruments
The FVOCI category is only available for nancial
assets that:
pass the contractual cash ow characteristics
assessment; and
are managed within the relevant business
model. (June 2012)
Yes there is currently no FVOCI measurement
category for eligible debt instruments in IFRS 9.
Proposed
approach to
the contractual
cash ows
characteristics
assessment
A nancial asset could qualify for a measurement
category other than FVTPL if its contractual terms
give rise, on specied dates, to cash ows that are
solely payments of P&I. (February 2012)
No
Interest is consideration for the time value of
money and for the credit risk associated with the
principal amount outstanding during a particular
period of time. (February 2012)
No
Principal is understood as the amount transferred
by the holder on initial recognition. (February 2012)
No
Principal is not currently dened in IFRS 9.
However, the basis of conclusions states that
cash ows that are interest always have a close
relation to the amount advanced to the debtor (the
funded amount).
APPENDIX A: SUMMARY OF IASBS REDELIBERATIONS
ON CLASSIFICATION AND MEASUREMENT
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What did the
IASB discuss?
What did the IASB tentatively decide? Is there an identied change to IFRS 9?
If yes, then what?
Although the IASB did not describe this as a
change from IFRS 9, we believe that the new
description of principal may have implications
in practice. For example, based on this new
perspective, bonds originally issued at par but
acquired by the holder at a substantial premium in
secondary markets and (contingently) prepayable
at par would appear not to be consistent with the
notion of solely P&I; this is because the holder
might not recover all of its initial investment.
If a nancial asset contains a component other
than principal and interest, then it is required to be
measured at FVTPL. (February 2012)
No
Assessment
of economic
relationship
between P&I
If a nancial asset only contains components
of principal and interest, but the relationship
between them is modied, then an entity needs
to consider the effect of the modication when
assessing whether the cash ows on the nancial
asset are solely P&I. (February 2012)
Yes this is an amendment to the application
guidance in IFRS 9.
The IASB believes that this change will address
application issues that have arisen in the
application of IFRS 9.
An entity would need to compare the nancial
asset under assessment to a benchmark
instrument that contained cash ows that were
solely P&I to assess the effect of the modication
in the economic relationship between P&I. An
appropriate benchmark instrument would be a
contract of the same credit quality and with the
same terms, except for the contractual term under
evaluation. (February 2012)
If the difference between the cash ows of the
benchmark instrument and the instrument under
assessment is more than insignicant, then the
instrument is required to be measured at FVTPL;
this is because its contractual cash ows are not
solely P&I. (February 2012)
Contingent cash
ows
A contractual term that changes the timing or
amount of payments of P&I would not preclude
the nancial asset from a measurement category
other than FVTPL. This is true as long as any
variability only reects the change in the time value
of money and the credit risk of the instrument.
(February 2012)
No
The probability of contingent cash ows that are
not solely P&I should not be considered. Financial
assets that contain contingent cash ows that
are not solely P&I are required to be measured at
FVTPL. There is an exception only for extremely
rare scenarios. (February 2012)
No
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What did the
IASB discuss?
What did the IASB tentatively decide? Is there an identied change to IFRS 9?
If yes, then what?
Prepayment
and extension
options
A prepayment or extension option, including those
that are contingent, does not preclude a nancial
asset from a measurement category other than
FVTPL. This is true as long as these features
are consistent with the notion of solely P&I.
(February2012)
No
Bifurcation of
nancial assets
and nancial
liabilities
Financial assets that contain cash ows that are
not solely P&I would not be eligible for bifurcation.
Instead, they would be classied and measured in
their entirety at FVTPL. (April 2012)
No
Financial liabilities would be bifurcated using the
existing closely related bifurcation requirements
currently in IFRS 9 and US GAAP. (April 2012)
The IASB also conrmed that the own credit
guidance in IFRS 9 would be retained. (April 2012)
No
Mechanics
of the FVOCI
category for
eligible debt
instruments
Interest income and credit impairment losses/
reversals on FVOCI assets should be recognised
in prot or loss using the same methods as for
nancial assets measured at amortised cost.
(May2012)
Yes there is currently no FVOCI measurement
category for eligible debt instruments in IFRS 9.
The cumulative fair value gain or loss recognised in
OCI should be recycled from OCI to prot or loss
when these nancial assets are derecognised.
(May 2012)
Yes there is currently no FVOCI measurement
category for eligible debt instruments in IFRS 9.
Reclassication The existing reclassication requirements in
IFRS9 will be extended to the FVOCI category.
(May 2012)
Yes and No there is currently no FVOCI
measurement category for eligible debt
instruments in IFRS 9, so in this sense there is an
identied change to IFRS 9. However, the existing
reclassication requirements in IFRS 9 (e.g.
when reclassication occurs) are not expected to
change, subject to further consideration by the
Boards at a future meeting on how to account for
reclassications.
Fair value option
(FVO)
The accounting mismatch FVO eligibility criterion
as stated in IFRS 9 will be extended to nancial
assets in the FVOCI measurement category. (June
2012)
Yes and No there is currently no FVOCI
measurement category for eligible debt
instruments in IFRS 9, so in this sense there is
an identied change to IFRS 9. However, the
accounting mismatch FVO eligibility criterion
as stated in IFRS 9 remains unchanged and is
merely extended to nancial assets in the FVOCI
measurement category.
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Publication name: IFRS Newsletter: Financial Instruments
Publication number: Issue 3
Publication date: June 2012
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IFRS Newsletter: Financial
Instruments is KPMGs
update on the IASBs nancial
instruments project.
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information on any of the matters
discussed in this Newsletter,
please talk to your usual local
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Acknowledgements
We would like to acknowledge the efforts of the principal authors of this publication: Nicolle Pietsch, Robert Sledge and Sze Yen Tan.