Changes to financial instruments…eventually…

The IASB has issued a package of amendments to the forthcoming financial instruments accounting standard IFRS 9, including delaying the effective date

On November 19, 2013, the IASB issued a package of amendments to the much-delayed new financial instruments accounting standard, IFRS 9. Here’s the very high-level summary:

“The amendments:

  1. bring into effect a substantial overhaul of hedge accounting that will allow entities to better reflect their risk management activities in the financial statements;
  2. allow the changes to address the so-called ‘own credit’ issue that were already included in IFRS 9 Financial Instruments to be applied in isolation without the need to change any other accounting for financial instruments; and
  3. remove the January 1, 2015 mandatory effective date of IFRS 9, to provide sufficient time for preparers of financial statements to make the transition to the new requirements.”

Delayed implementation date

For many smaller entities, only the last of these is likely to be relevant. In their disclosures on future accounting standards, such entities disclosed for a while that IFRS 9 was expected to be effective in 2013; then that was deferred to 2015. Because a major piece of the standard, relating to impairment of financial assets, remains outstanding, 2015 now seems to leave too little preparation time for entities that would be materially affected by that aspect of the standard. So, for now, we don’t know the effective date, although the IASB subsequently communicated it won’t be in 2016 either. However, entities can adopt the standard as it stands, if they choose.

I must admit to some ambivalence on this point. If one assumes the changes to IFRS 9 would provide value to investors (and if not, there’s no point to the exercise), then every year that they’re not adopted ought to mean that investors are making sub-optimal decisions, which should be an urgent matter. Put another way, the more IFRS 9 (or any standard) gets delayed, the more it seems to convey that it doesn’t really matter if it ever gets implemented or not. Of course, I’m not denying the real cost of such conversions for some entities, but we also know that such costs can easily be overstated; if something is truly worth doing, there will always be a way. Anyway, I expect most issuers will have little patience for such hard-line reasoning!

Hedge accounting

Hedge accounting among Canadian entities, especially smaller ones, has become relatively rare under IFRS, although that may partly reflect the very issue that the amendments set out to address, the excessive complexity of the existing requirements, and the daunting amount of work required to demonstrate that a particular hedging strategy conformed to the requirements of IAS 39. The amendments try to bring things closer to the real world, for instance by specifying: “An entity’s risk management is the main source of information to perform the assessment of whether a hedging relationship meets the hedge effectiveness requirements. This means that the management information (or analysis) used for decision-making purposes can be used as a basis for assessing whether a hedging relationship meets the hedge effectiveness requirements.” The amendments go on to emphasize that the assessment of hedge effectiveness “can be a qualitative or a quantitative assessment.” Still, much will depend on whether the critical terms, and how they respond to changes, are clear in any particular arrangement.

Among much else, the amendments remove the restriction in IAS 39 that a non-financial item could only be designated as a hedged item in its entirety, “because of the difficulty of isolating and measuring the appropriate portion of the cash flows or fair value changes attributable to specific risks” (except for foreign exchange risk). So for example, to use one of the IASB’s examples, an issuer might now apply hedge accounting solely to the “oil price component of jet fuel price exposure.”

“Own credit”

For the third item: once it’s effective, IFRS 9 will allow a financial liability that would otherwise be measured at amortized cost to be designated at fair value through profit or loss when this results in more relevant information (for example, by eliminating an accounting mismatch). For such items, the amount of change in the fair value attributable to changes in the liability’s credit risk will be presented in other comprehensive income; the rest of the change will be presented in profit or loss (otherwise, for instance, an entity applying this option might recognize gains in profit or loss when its credit worthiness declines, which has generally struck people as an odd result). The new amendments allow an entity to apply this aspect of IFRS 9 early, even if it doesn’t adopt any other piece of the standard before the effective date; otherwise, it’s all or nothing. In effect, as the IASB sums it up, this “allows an entity to continue to measure its financial instruments in accordance with IAS 39 but to benefit from the improved accounting for own credit in IFRS 9.”

So, for some issuers (some in the financial industry; others with a strong motivation to apply hedge accounting) that’s probably the accounting event of the year; for others, it’s nothing to worry about. Not until 2017 at the earliest!

The opinions expressed are solely those of the author

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