GLOBAL AUDIT LEARNING AND DEVELOPMENT IAS 32, IAS 39, …

GLOBAL AUDIT LEARNING AND DEVELOPMENT

IAS 32, IAS 39, IFRS 7 & IFRS 9

AA 2013 - 2014

Università degli Studi di Bergamo

Anael Francillon

Ivan Lucci

Bergamo, 13 febbraio 2014

.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular

individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such

information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act

upon such information without appropriate professional advice after a thorough examination of the particular situation.

© 2014 KPMG S.p.A., an Italian limited liability share capital company and a member firm of the KPMG network of independent member

firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. IAS 32, 39 & IFRS 7 - Accounting For Financial Instruments

2

Market trends as reflected in IAS 32 and 39

Key principles of the Standard

Increased complexity

Detailed disclosures

Use of fair values

Largely rules based

Harmonisation of markets

All derivatives are

measured at fair value

Many other financial

instruments measured

at fair value

Measurement of the hedging instrument



3

Definition of financial instruments

Financial

asset

Cash

Equity instrument of another entity

Contractual right to receive cash or another financial asset (for example, loans and receivables) or to exchange financial assets or liabilities under potentially favourable conditions

Certain contracts settled in the entity’s own equity

Financial

liability Equity instrument

Contractual obligation to deliver cash (for example, accounts payable) or another financial asset or to exchange financial asset or liabilities under potentially unfavourable conditions

Certain contracts settled in the entity’s own equity

Except for certain puttable financial instruments and obligations arising only upon an entity's liquidation

Contract evidencing a residual interest in the assets of an entity after deducting all of its liabilities

A financial instrument is a contract that gives rise to:

a financial asset of one entity and

a financial liability or equity instrument of another entity



4

Categories of financial assets

4 categories of financial assets:

■ A financial asset at fair value through profit or loss

■ Held-to-maturity investments

■ Loans and receivables

■ Available-for-sale financial assets



5

Recognition

All financial assets and financial liabilities, including derivatives,

should be recognised in the statement of financial position when the

entity becomes party to the contractual provisions of the instrument

Financial assets

@

‘fair value less

transaction costs in

certain

circumstances’

Financial liabilities

@

‘fair value less

transaction costs in

certain

circumstances’



6

Categories of financial assets

Category Definition

Financial assets at fair value through profit or loss

■ Financial assets held for trading

■ Derivatives, unless accounted for as a hedging instrument

■ Financial asset designated to this category under the fair value option (must meet certain criteria)

Loans and receivables

Non-derivative financial assets with fixed or determinable payments that are not quoted in an active market

Held-to-maturity investments

Non-derivative financial assets with fixed or determinable payments and fixed maturity that the entity has the positive intent and ability to hold to maturity

Available-for-sale financial assets

All financial assets that are not classified in another category are classified as available-for-sale



7

Categories of financial liabilities

Category Definition

Financial liabilities at fair value through profit or loss

■ Financial liabilities held for trading

■ Financial liability designated as at fair value through profit or loss on initial recognition (fair value option)

■ Derivatives unless accounted for as hedging instruments in a cash flow hedge

Other financial liabilities – at amortised cost

All financial liabilities that are not classified at fair value through profit or loss



8

Initial measurement

■ Measured at fair value on initial recognition

■ Transaction costs are included in the initial measurement of financial

instruments that are not measured at fair value through profit or loss

■ Transaction price is presumed to be the best evidence of fair value at initial

recognition, unless another amount is determined by reference to

observable current market transactions or by using valuation techniques

that use only data from observable markets

■ Applies to all financial instruments – whether or not negotiated on an arm’s

length basis (e.g., interest-free loans from a shareholder or government)



9

Subsequent measurement of financial instruments

Instrument Measurement Value changes

P&L

Not relevant

(unless impaired)

P&L

P&L

Held-to-maturity investments

Amortised cost

(effective interest rate)

Not relevant

(unless impaired)

Amortised cost

(effective interest rate) Loans and receivables

Available-for-sale Fair value

Financial assets at fair value through profit or loss

Fair value

Derivatives Fair value

Financial liabilities at fair value through profit or loss

Fair value

Other liabilities Not relevant Amortised cost

Other comprehensive income (OCI) (unless impaired)



10

Guidance on fair values

Active market: published price quotations

No active market: valuation techniques using as many market inputs as possible



11

Amortized cost and effective interest method

Amortised cost is calculated using the effective interest rate method

Initial recognition amount

Amortised cost

Cash received

Interest income / expense

Impairment

At the end of each reporting period apply the effective interest rate method to determine interest income and interest expense

= -/+ - -



12

Reclassifications from held-to-maturity category

And classification as AFS assets for two years

Change of intent or

ability

reclassify ALL instruments

‘Tainting’ leads to measurement at fair value

Sales before maturity (with certain exceptions)

reclassify ALL instruments



13

Reclassification of certain financial assets

■ Reclassification out of fair value through profit or loss is

– Permitted for any non-derivative financial asset, which was not designated as

fair value through profit or loss at initial recognition, subject to certain criteria

being met

■ Reclassification out of available for sale (‘AFS’)

– Permitted for a financial asset in the AFS category to the loans and receivable

category if certain criteria are met

■ Assessment for separation of embedded derivatives



14

Fair value definition

IAS 39.9

■ Value at which an asset can be obtained,

■ Or a liability settled

■ In a free transaction

■ Through knowledgeable parties

■ And available



15

Fair Value Hierarchy

Level 1 Fair values measured using quoted prices (unadjusted) in active

markets for identical assets or liabilities

Level 2 Fair values measured using inputs other than quoted prices included

within Level 1 that are observable for the asset or liability, either

directly (i.e. as prices) or indirectly (i.e. derived from prices)

Level 3 Fair values measured using inputs for the asset or liability that are

not based on observable market data (i.e. unobservable inputs)

















16

Impairment requirements

■ A financial asset or a group of financial assets is impaired if, and only if,

– there is objective evidence of impairment as a result of one or more events

that occurred after initial recognition; and

– the loss event has an impact on estimated future cash flows than can reliably

be measured

■ An impairment loss is measured as the difference between:

– the asset’s carrying amount and the present value of estimated future cash

flows - for loans and receivables or held-to-maturity investments; and

– the acquisition cost (net of any principal repayment and amortisation) and

current fair value, less any impairment losses previously recognised– for

available-for-sale financial assets



17

Objective evidence of impairment for financial

assets measured at amortized cost

■ Significant financial difficulty of the issuer

■ Payment defaults

■ Renegotiation of asset terms due to financial

difficulty of the borrower

■ Significant restructuring due to bankruptcy or

financial difficulty

■ Disappearance of an active market for the assets

concerned due to financial difficulties

■ Measurable decrease in the estimated future cash

flows of the financial asset(s) concerned

Examples of loss events that may provide objective evidence of impairment



18

Impairment assessment of financial assets

measured at amortized cost

Objective evidence of impairment of individually significant assets?

Evidence of impairment for group of financial assets (including those

individually assessed and not found impaired) with similar credit risk (i.e.

“collective assessment”)

Measure impairment collectively

No impairment

Measure impairment Yes

No

Yes

No



19

Loans and receivables - Evaluation of impairment

on a portfolio basis

■ Future cash flows

– Estimate cash flows,

– Based on historic loss experience,

– Adjusted for current conditions as

necessary

■ Discount rate

– Original effective interest rate

■ Losses incurred but not reported – At each year end the present value of the estimated cash flows is re-calculated

and impairment loss recognised for the difference between this amount and

the carrying value of the portfolio. The estimated cash flows take into account

incurred losses, not expected future losses

– When loans are identified as individually impaired they are removed from the

portfolio (i.e. no longer part of collective impairment assessment)



20

Loans and receivables – A possible approach to

measurement of incurred losses on a portfolio basis

■ Incurred loss defines impairment loss

■ Historic loss rate is determined using historical data, adjusted for economic conditions existing at the end of the reporting period

■ The emergence period is the average lag between incurrence of loss and confirmation of loss dates

■ Incurrence loss date is the date on which impairment loss is incurred on an individual asset basis

■ Confirmation loss date is the date on which objective evidence of impairment is identified on an individual asset basis

Incurred

loss

Historic

loss

rate

Emergence

period

Portfolio balance = x x



21

Impairment of available-for-sale equity securities

■ Additional indicators of impairment for equity securities

– Adverse effects of changes in technological, market, economic or legal

environment, in which the entity operates

– Significant or prolonged decline in the fair value of an investment below cost

Impairment loss cannot be reversed

through profit or loss as long as the

asset continues to be recognised

Equity

instruments



22

Impairment of available-for-sale debt securities

■ Indicators of impairment for debt securities (similar to those for financial assets

recognised at amortised cost)

– Significant financial difficulty of the issuer

– Bankruptcy or financial reorganisation of the issuer

– Disappearance of an active market for the bonds concerned

– Measurable decrease in the estimated future cash flows

Impairment loss reversed through profit or

loss if subsequently the fair value of the debt

instrument increases and the increase can

be objectively related to an event occurring

after the loss was recognised

Debt instruments



23

Derecognition of a financial asset

■ First, consolidate all subsidiaries (including all SPEs)

– Derecognition provisions are applied on a consolidated level

■ Then, consider the subject of the derecognition analysis (financial asset,

group of similar financial assets or a portion of a financial asset)

■ Then, apply derecognition rules:

Derecognise when contractual rights to cash flows expire or

– There is a ‘transfer’ of a financial asset and

– That transfer qualifies for derecognition



24

Derecognition of a financial asset (cont.)

■ ‘Transfer’ of a financial asset requires

– A transfer of the contractual rights to receive the cash flows; or

– Meeting the ‘pass-through requirements’ in IAS 39.19

■ If financial asset has been transferred, then assess whether transfer

qualifies for derecognition

– If substantially all risks and rewards are retained – retain the asset

– If substantially all risks and rewards are transferred - derecognise

– If some but not substantially all risks and rewards have been transferred:

■ Control -> Continuing involvement

■ No Control -> Derecognise

A very mixed model !



25

Derecognition of a financial liability

■ Financial liability (or part thereof) is removed from the statement of

financial position when it is extinguished, i.e. when the obligation is

discharged or cancelled or expires



26

Need for Hedging

Risk associated to financial assets or liabilities that might be subject to

hedging:

■ Interest rate risk

■ Currency exchange risk

■ Credit risk

■ Market price risk



27

Benefit of hedge accounting

0

1 2 Cum

Hedged item 0 -20 -20

Hedging instrument 20 20

20 -20 0

A

A Accelerate recognition of gain or loss on hedged item

B

B Defer recognition of gain or loss on hedging instrument

Reporting the effects in the same period to avoid a mismatch in

timing of gain and loss recognition:



28

Cash flow hedges

■ Hedge of exposure to variability in cash flows that is:

– attributable to a particular risk associated with a recognised asset or liability or a

highly probable forecast transaction (including inter-company transactions); and

– could affect profit or loss

Hedges of a net investment in a foreign operation

Hedge accounting models

Fair value hedges

■ Hedge of exposure to changes in fair value of:

– a recognised asset or liability; an unrecognised firm commitment; or an identified

portion of any of these two;

– that is attributable to a particular risk; and

– could affect profit or loss



29

Fair value hedge accounting model

Fair value

Measurement of hedging instrument

Measurement of hedged item

Fair value with

respect to risk

being hedged (*)

Profit

or

loss

(*) This applies even if a hedged item is otherwise measured at cost

Changes in fair value



30

Cash flow hedge accounting model

Changes

in fair value

Effective Other

comprehensive

income (OCI)

Profit

or loss

(*)

(*) Based on timing of earnings impact of hedged item (e.g. cost of sales, depreciation, interest)

Measurement of hedging instrument

Fair value



31

Hedging instrument

■ The following can be designated as hedging instruments:

– derivatives with third parties

– non-derivatives for a hedge of foreign currency risk only

– combination of two or more derivatives or non-derivatives, except for net written options

– A proportion of a financial instrument (for example, 50% of the fair value changes of an

interest rate swap)

■ Hedging instrument may not be designated for a portion of its remaining period to

maturity

■ Derivatives should be designated as hedging instruments in their entirety. Two

exceptions to this rule:

– separating the intrinsic value and time value of an option and designating the intrinsic

value

– separating the interest element and spot price element in a forward and designating the

spot price element



32

Hedge accounting criteria

■ The hedge relationship is formally designated and documented at inception

of the hedge

■ The hedge is expected to be highly effective and effectiveness is reliably

measurable

■ The hedge is assessed on an ongoing basis and remains highly effective

during the entire period of the hedge designation

■ For a cash flow hedge of a forecast transaction, the forecast transaction is

highly probable



33

Hedge accounting criteria (continued)

■ Formal documentation is required at inception of the hedge and must

include:

– Identification of the hedging instrument and the hedged item

– The nature of the risk being hedged

– The risk management objective and strategy for undertaking the hedge

– How effectiveness will be assessed (prospective and retrospective)



34

Assessment of hedge effectiveness

■ Prospective assessment – At inception and at a minimum at each

reporting date throughout the term of the hedge designation

– Highly effective in offsetting changes in fair value or cash flows

– Testing methods (e.g. statistical analysis, off-set methods, comparing all critical terms)

– Hedging results within the range of 80-125%

■ Retrospective assessment

– At a minimum at each reporting date

and throughout the term of the

hedge designation

– Testing methods (e.g. offset method,

statistical analysis, etc.)

– Hedging results within the range of

80-125%

Hedge accounting; ineffectiveness to profit or loss

125%

100%

80%


Discontinue hedge accounting

Discontinue hedge accounting


IFRSs do not prescribe the methods that should be used in measuring effectiveness



35

Hedges of a net investment

■ Must meet requirements for hedge accounting

■ A net investment hedge is a hedge of the foreign currency exposure on a

net investment in a foreign operation using a derivative, or a non-derivative

monetary item, as the hedging instrument

■ Effective portion of gain or loss on hedging instrument recorded in the

same manner as the foreign currency translation gain or loss i.e., in OCI

■ Ineffective portion of gain or loss on hedging instrument recognised in

profit or loss

■ Reclassified from OCI to profit or loss as a reclassification adjustment upon

disposal of net investment



36

Discontinuation of hedge accounting

Fair value hedges Cash flow hedges

Future changes in fair value of hedging instrument

a) Derivative

b) Non-derivative (FX remeasurement)

Continue to be recognised in profit or loss

Continue to record FX remeasurement in profit or loss

Recognized immediately in profit or loss

Account for FX remeasurement in profit or loss

Future accounting for the hedged item Apply applicable IFRS principles for the items

Any hedging adjustments made previously to hedged item for which effective interest rate method is used are amortised to profit or loss by adjusting the effective interest rate

No change in accounting

Effective amounts previously recorded in OCI

for a forecast transaction not expected to

occur within the original time period or a

relatively short period thereafter

N/A Reclassify from OCI to profit or loss

immediately

Effective amounts previously recorded in OCI

for a forecast transaction that is no longer

probable but still expected to occur

N/A

Reclassify from OCI when the

transaction occurs and affects profit

and loss



37

Liability or equity?

■ Classification assessed at initial recognition and generally not subsequently revised

for changes in circumstances (except for puttable financial instruments and

obligations arising on liquidation)

■ However, subsequent change in terms and conditions of instrument may require

reclassification

■ Determine liability component

– fair value

– include embedded derivatives

■ Equity is residual

■ No gain or loss on separation

Yes

Liability

No

Equity

Part

Compound instrument

Is there a contractual obligation that the issuer cannot avoid?



38

Offsetting a financial asset and a financial liability

An intention to settle net or to realise the asset and settle the liability

simultaneously

& ■ Master netting agreements

■ Several instruments used to emulate a single instrument (synthetic

instrument)

■ Items with the same risk, but different counterparties

■ Financial assets pledged as collateral for non-recourse liabilities

■ Assets set aside in a trust to discharge a liability that have not been

accepted by the creditor (sinking fund arrangements)

■ Obligations as a result of losses recoverable via insurance

A legally enforceable right to offset



39

Nature and Extent of Risks Arising from Financial

Instruments

■ Qualitative disclosures

– For each type of risk (e.g., credit, liquidity and market) arising from financial

instruments, disclose:

■ The exposures to risk and how they arise

■ Objectives, policies and processes for managing the risk and methods used to

measure the risk

■ Any changes to the above from the previous period



40


Instruments (continued)

■ Quantitative disclosures

– For each type of risk arising from financial instruments, disclose:

■ Summary quantitative data about the risk exposure as provided to key

management personnel

■ Detailed disclosures to the extent not disclosed already from the point above

■ Concentrations of risk if not included above



41


Instruments (continued)

■ Quantitative disclosures (continued)

– Credit risk

by class of financial instruments:

■ Maximum credit exposure (without collateral or other credit enhancements)

– In respect of the above, description of collateral and other credit

enhancements

■ Information about credit quality of financial assets that are neither past due

nor impaired

■ Carrying amount of renegotiated financial assets

■ Analysis of financial assets past due or impaired

– In respect of above, description of collateral and other credit enhancements

and unless impracticable, an estimate of their fair value



42

IFRS 9

Background

Additions to IFRS 9

Fair Value Option

Effective date and transition



43

Background

Discussion Paper Reducing Complexity in Reporting Financial Instruments in

2008

ED/2009/7 Financial Instruments: Classification and Measurement

Discussion Paper Credit Risk in Liability Measurement (2009)

IFRS 9 Financial Instruments (2009)

■ Dealt only with financial assets

■ Concerns raised about recognising in profit or loss the effects of changes in the

credit risk of financial liabilities

ED/2010/4 Fair Value Option for Financial Liabilities

Disclosures – Transfers of Financial Assets (Amendments to IFRS 7)

(October 2010)



44

IFRS 9

Background

Additions to IFRS 9

Fair Value Option




45

Additions to IFRS 9

Additions to IFRS 9 Financial Instruments

Integration of the guidance in IAS 39 Financial Instruments: Recognition and Measurement on

■ Classification and measurement of financial liabilities

– Bifurcation of embedded derivatives (including IFRIC 9 Reassessment of Embedded Derivatives)

■ Derecognition of financial assets and financial liabilities

■ Fair value measurement [pending a new FVM standard]

■ Renumbering/restructuring, minor edits, Guidance on Implementing

Two changes to the guidance on classification and measurement of financial liabilities

■ Accounting for derivatives linked to unquoted equity instruments for which fair value is not reliably determinable

■ Application of the fair value option for financial liabilities



46

Deletion of exception

IAS 39: Exception from fair value measurement for unquoted equity

investments for which fair value is not reliably determinable and linked

derivatives

■ IFRS 9 (2009) eliminated exception for financial assets

■ IFRS 9 (2010) extends elimination to derivative liabilities



47

IFRS 9

Background

Additions to IFRS 9

Fair Value Option




48

Conditions for the application of the fair value

option

IFRS 9 (2010) retains the current conditions in IAS 39 for irrevocable

designation at initial recognition of a financial liability as fair value

through profit or loss:

elimination or significant reduction of an accounting mismatch,

management and performance evaluation of a group of financial liabilities or

financial assets and financial liabilities on a fair value basis, or

financial liability host contract with significant embedded derivative which may

have to be separated if the hybrid instrument is not accounted for at fair value

through profit or loss.



49

Presentation of gains/losses on FVO liabilities

Presentation of fair value changes of FVO financial liabilities:

■ amount of change in the fair value of the financial liability that is attributable to

changes in its credit risk → OCI

■ remaining amount of change in the fair value → P&L

One-step approach

■ ED/2010/4 proposed two-step approach

No subsequent recycling from OCI to profit or loss

■ Transfer within equity possible

■ Amendment to IFRS 7: if a liability is derecognised during the period, the amount (if

any) presented in other comprehensive income that was realised at derecognition

is disclosed



50

Presentation of gains/losses on FVO liabilities

Exceptions from split presentation

■ If presenting credit risk changes in OCI would create or enlarge an accounting mismatch in profit or loss, then all fair value changes are presented in profit or loss

– Determination made at initial recognition and not reassessed

– Assess whether effects of change in credit risk of liability will be offset by change in FV of another financial instrument measured at FVTPL

– Assessment based on economic relationship between the characteristics of the instruments

– Board expects these circumstances to be “rare”

– Mismatch cannot arise solely from measurement method – e.g. failure to separate liquidity risk changes from credit risk changes

– Consistent methodology/ies for assessment – detailed description disclosed

■ All gains and losses on loan commitments and financial guarantee contracts that are designated as fair value through profit or loss are presented in profit or loss



51

Determining effects of credit risk changes

Reference to the definition of credit risk in IFRS 7 Financial Instruments: Disclosures

■ Risk that the issuer will fail to discharge an obligation

■ Relates to failure to perform on the particular liability

■ Does not necessarily relate to the creditworthiness of the issuer (e.g. where liability is collateralised)

■ Differentiation from unit-linking and asset-specific performance risk

The standard utilises the guidance in IFRS 7 on determining the amount of the change in fair value that is attributable to changes in the credit risk of the liability

■ “Default”: Amount of total change in fair value that is not attributable to changes in market conditions that give rise to market risk

■ Alternative method that the entity believes provides a more faithful representation



52

Agenda

Background

Additions to IFRS 9

Fair Value Option




53

Effective date

Effective date:

IFRS 9 (2010) is effective for annual periods beginning on or after 1 January

2013. Earlier application is permitted.

IFRS 9 (2010) supersedes IFRS 9 (2009) and IFRIC 9 Reassessment of

Embedded Derivatives.

For annual periods beginning before 1 January 2013, an entity may elect to

apply IFRS 9 (2009) rather than IFRS 9 (2010).



54

Transition

Transition

IFRS 9 (2010) generally is applied retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

■ Contains several exceptions from this principle, mainly based around the entity’s date of initial application of the standard. These exceptions are largely consistent with those in IFRS 9 (2009).

If an entity adopts IFRS 9 (2010) without having first adopted IFRS 9 (2009), then it has a single date of initial application for IFRS 9 (2010) in its entirety.

If an entity early adopts IFRS 9 (2009) and then later adopts IFRS 9 (2010), it is not permitted to reapply the transitional provisions of IFRS 9 (2009) when adopting IFRS 9 (2010).

IFRS 9 (2010) does not include any ability or requirement to designate or de-designate a liability as fair value through profit or loss at initial application in addition to those included in IFRS 9 (2009).

■ However, at the date of initial application of IFRS 9 (2010), an entity is required to determine whether including the effects of changes in credit risk on a liability already designated as fair value through profit or loss would create or enlarge an accounting mismatch based on facts and circumstances at that date.



55

Effective date

Project News:

19 November 2013: IASB completes important steps in reform of financial

instruments accounting and mandatory effective date.

1 August 2013: Project update: ‘Own credit’ and mandatory effective date of

IFRS 9

14 December 2012: IFRS 9—Limited Amendments, Significant Improvements

5 December 2012: Live webcast on Classification and Measurement: Limited

Amendments to IFRS 9

28 November 2012: The IASB issued an Exposure Draft Classification and

Measurement: Limited Amendments to IFRS 9 (Proposed amendments to

IFRS 9 (2010))

16 December 2011: IASB issued amendments to IFRS 9 Financial

Instruments

Thank you

Anael Francillon

Senior Manager, Audit

KPMG S.p.A.

Via Rosa Zalivani, 2

31100 Treviso TV

Telephone +39 0422 576711

Ivan Lucci

Partner, Audit

KPMG S.p.A.

Via Camozzi, 5

24121 Bergamo BG

Telephone +39 035 240218

© 2014 KPMG S.p.A., an Italian limited liability

share capital company and a member firm of the

KPMG network of independent member firms

affiliated with KPMG International Cooperative

("KPMG International"), a Swiss entity. All rights

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GLOBAL AUDIT LEARNING AND DEVELOPMENT IAS 32, IAS 39, …

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Transcript of GLOBAL AUDIT LEARNING AND DEVELOPMENT IAS 32, IAS 39, …