IASB completes Phase 1 of IFRS 9: Financial Instruments — Classification and Measurement
Finance Nation
January 2011
Everyone remembers recommendations issued in 2009 by the G20 and market participants regarding the need to redesign a certain number of international accounting standards, and in particular those relating to financial instruments. Indeed, the current standard IAS 39 related to the accounting and valuation of the financial instruments and the underlying fair value concept have been accused of all the ills of the financial crisis: too complex, misunderstood, having too much estimates and judgment embedded in the application of the standard, inducing an unhealthy volatility in earnings...
The recommendations aimed primarily at improving the rules concerning the valuation of the financial instruments based on the liquidity and the horizon of detention while strengthening the framework of the fair value accounting. It looked also at improving the terms of the credit risk provisioning, at enhancing the quality of disclosures related to off-balance sheet exposures, at reaching a better convergence of accounting standards at the global level and a reduction in the complexity of understanding and implementation of the accounting standards on financial instruments. Pressure on this subject on the International Accounting Standards Board (the IASB) was and is still enormous.
IAS 39 has therefore been subject to a draft recast into 3 phases: phase 1 devoted to the assessment of the financial assets and financial liabilities, the phase 2 relating to the depreciation of financial assets and the phase 3 dealing with hedge accounting. In November 2009, the IASB issued the first part of Phase 1 of IFRS 9 dealing with the classification and measurement of financial assets within the scope of IAS 39. On 28 October 2010, the ISAB issued amendments to IFRS 9 to address financial liabilities brining phase 1 of the project to an end. The first exposure draft on the phase 2 was issued in November 2009, then a second exposure draft with a view to simplification for a completion is scheduled for the 2nd quarter of 2011. First exposure draft on the phase 3 followed for a completion of all IAS 39 revision project is scheduled for the 2nd quarter of 2011. This very ambitious schedule might nevertheless be reconsidered and the issuance of the final standard extended until late 2011.
Recall that the implementation of phase 1 of IFRS 9 is required starting exercises beginning from 1 January 2013 with possibility of early application. The IASB intends to grant a period of three years from the date of publication of the phase 2 and the first date of its application. At the date of application of phase 3, nothing is unclear to this day.
The major issue is that the European Union has not yet adopted IFRS 9. This means that European companies and banks cannot apply this standard while other non-European entities may do so early. This does not encourage therefore one of the objectives pursued in the revision of standards, to ensure better comparability between companies and banks. It appears that the European Union will likely wait for the three phases of the project redesign to be finalized to pronounce on the non-adoption of the standard or its adoption in whole or part.
Indeed, experience has shown with IAS 39 that one (or several) carve-out is never excluded. This puts European companies and banks in a delicate situation where, even if they do not know the final position of the European Union (rejection, partial or full adoption), they are already obliged to conduct simulations to determine the impacts of IFRS 9 on their financial statements, their performance and, where appropriate, possible impacts in particular tax and regulatory matters. This is even more complicated given the fact that phases 2 and 3 of the project are not completed.
The goal of phase 2 is to meet, once more, the criticism expressed in the IAS 39 in the context of the financial crisis. Depreciation model required by IAS 39 was widely called into question because based on an effective interest rate which ignores expected losses from the start, only incurred losses are subject to provisioning. The banking sector specifically criticized this model considered inconsistent in that the anticipated losses are implicit in the initial assessment (at fair value) but are not reflected in the effective interest rate of the subsequent valuation; the products of interest are overstated until the occurrence of an event of default and the sudden devaluation at the occurrence of this event is for part a reversal of previously recorded income. Exposure draft thus plans to correct this inconsistency.
The objective of the phase 3 is to simplify the current provisions of hedge accounting and reflect better the implementation of risk management by companies by aligning at maximum accounting treatments and risk management practices. At this stage, the project does however not cover macro-hedging issues particularly relevant to credit institutions, or coverage of net investment.
Judging by the amendments definitively issued since November 2009, we could be tempted to say that there is no much progress between this date and 28 October 2010. However, if one follows closely all developments and reflections related to the phases 2 and 3, we realize the wealth and breath of material and redesign project. And yet again, we can ask ourselves if one of the objectives pursued, namely the simplification of the standards will be achieved with IFRS 9. The future will tell us but it is reasonably allowed to doubt.
+ 352 42 124 8341