The current market conditions have seen many investment holding companies recognising substantial unrealised losses in their profit and loss results as a consequence of the market value of their investments declining. This occurs where an investment was acquired with the intention of selling it in the near term (technically referred to as a ‘held for trading’ investment). With the trying times many entities have put a hold on actively trading these assets and are proposing to hold the assets, in some cases for more than 12 months, in the hope that the market will recover in the near future.

Is this change in investment strategy then deemed to be a change in the reclassification of the financial instrument to an ‘available for sale’ financial asset? These are financial assets that are expected to be held longer term; therefore, movements in their market value only impact profit and loss when impaired or sold. This reduces volatility in an entity’s earnings when reporting profit and loss.

Up until a few weeks ago, a reclassification of these instruments was not permitted, regardless of a change in intent due to forced circumstances. US GAAP permits the reclassification and with the current convergence of IFRS with US GAAP, the Australian Accounting Standards Board has amended AASB139: Financial Instruments Recognition and Measurement and AASB 7: Financial Instruments Disclosure to now permit a reclassification of non-derivative financial assets only in a ‘rare’ circumstance, effective from 1 July 2008.

‘Rare’ is undefined but a credit crunch may be a prime example. Entities that reclassify their investments to align with its revised investment strategies could significantly improve their reported profit and loss
and enhance their ability to declare dividends out of profits.




The fair value at the date of restatement becomes the new amortised cost. Any gains or losses previously recognised in profit and loss are not reversed. The accounting standard sets out the disclosure that is required when a reclassification is adopted.

In determining fair value, the best evidence is an active market. The significant decline in volume and level of trading over the past few months has led an active market to become relatively inactive. Fair value has become increasing more difficult to determine.

Fair value should be determined based on a price at which an ‘orderly’ transaction would take place between market participants at measurement date and not a price in a forced liquidation or distressed sale. Even with an inactive market one cannot assume all market activity represents a forced transaction. Valuation techniques may be utilised using the entity’s own assumptions about future cash flows and appropriate risk-adjusted discount rates when observable market data is unavailable.

It will become more common to see two entities valuing the same instrument to arrive at a different fair value.

Financial assets are to be tested for impairment at each reporting date. ‘Significant’ or ‘prolonged’ decline in fair value for equity instruments is an indicator of impairment. ‘Significant’ or ‘prolonged’ is not defined in the accounting standard. As a rule of thumb a decline of greater than 20 per cent is deemed to be ‘significant’ and a period of greater than 12 months is deemed to be ‘prolonged’.

As a closing comment, the amendment above offers a once-off reclassification only.

A favourable future change in the market will not see the accounting standard permit an entity to revert investments to its original classification to once again take advantage
of positive fair value movements in its income statement.

Sylvia Wallace, Sydney