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- AASB 139 Revised – Part 1 out soon!
AASB 139 Revised – Part 1 out soon!
- By Rob Mackay
- Published 24/09/2009
- September 2009
- Unrated
The current version of AASB 139 is a reasonably difficult standard to interpret and apply, as it is a predominantly a ‘rules based’ standard. It is for this reason that the IASB and the FASB have been working on a more ‘principles based’ standard, for the last few years, to make it easier to understand and apply.
Given the onset of the global economic crisis, this project became a high priority. A new standard dealing with issues of ‘measurement’ and ‘classification’ is now aimed for release such that it may be possible for early adoption for December 2009 year end reporting entities. It is not expected to be mandatorily applicable until 1 January 2012.
ED 184 was published in July 2009 and reflects some of the issues and recommendations put forward by the Financial Crisis Advisory Group. Given the urgency of the review, present consensus would appear to be that the final version of the standard is likely to closely resemble the ED.
The draft essentially proposes measurement at ‘fair value’ as the default position for financial assets and financial liabilities. A financial asset or liability could be measured at amortised cost only where it is determined that the instrument has ‘basic loan features’ and the instrument
is managed on a ‘contractual yield basis’.
In short, basic loan features are contractual terms that will trigger cash flows of principal and interest. For example, contractual terms may include returns to the holder that are fixed or variable (or a combination thereof) where interest compensates the issuer for the time value of money and the credit risk assumed.
Financial instruments are managed on a contractual yield basis only when they are monitored by key management personnel of the entity on the basis of their contractual cash flows. For example, trade receivables and payables, general borrowings and debentures would generally be managed on the basis of the interest and principal payments or receipts to which the entity is exposed or entitled.
Financial assets and liabilities measured at fair value.
Unless a financial instrument satisfies the conditions to be measured at amortised cost, the instrument must be measured at fair value. This includes instruments that were previously carried at cost under the existing AASB 139 because they do not have a quoted market price and their fair values cannot be reliably measured. In other words, the ‘cost-exemption’ will no longer be available.
Subject to a couple of exceptions, changes in fair value shall be recognized through the income statement and so this will introduce a greater degree of volatility
in reported earnings than is currently the case.
The exceptions to this rule are:
It is thought that entities will be attracted to coupling an equity investment to their statement of OCI where the investment is held for strategic reasons as opposed to the generation of capital and/or revenue gains.
Another attraction with such a classification will be the ability to essentially do away with impairment testing of such investments. This proved to be a significant area of contention this reporting season under the current AASB 139 where investments whose decline in value below cost was determined as being ‘significant’ or ‘prolonged’ had to take an impairment hit to the income statement.
This will not be an issue for OCI equity investments under the proposals since all fair value movement will be posted through OCI. On the downside of such classification is that any dividends generated on such investments will also be recognised through OCI and not through profit or loss. Listed investment companies may therefore be forced to adopt the ‘fair value through profit or loss’ classification so that their income statement reflects the true nature of their operations with the associated fair value volatility.
There will not be any recycling of gains or losses on disposal of OCI investments through the income statements, and it should also be noted that the OCI designation is an irrevocable election once made.
Benefit of early adoption?
A benefit that is likely to be looked at closely by entities carrying large portfolios of currently impaired available-for-sale (‘AFS’) equity investments would be the ability to classify such assets at fair value with increments in value to be taken to the income statement. This would circumvent the current AASB 139 requirement to book revaluation increments on AFS investments back through an equity reserve despite having just taken impairment charges through the profit and loss in the last reporting period.
Further parts to come
These changes represent phase one of a three phase process. As each phase is completed, the IASB will delete the relevant portions of the current IAS 39 (i.e. AASB 139).
Other phases of the overall project will deal with impairment of financial assets (exposure draft expected to be published in October 2009) and hedge accounting (exposure draft expected to be published in December 2009).
Given the onset of the global economic crisis, this project became a high priority. A new standard dealing with issues of ‘measurement’ and ‘classification’ is now aimed for release such that it may be possible for early adoption for December 2009 year end reporting entities. It is not expected to be mandatorily applicable until 1 January 2012.
ED 184 was published in July 2009 and reflects some of the issues and recommendations put forward by the Financial Crisis Advisory Group. Given the urgency of the review, present consensus would appear to be that the final version of the standard is likely to closely resemble the ED.
The draft essentially proposes measurement at ‘fair value’ as the default position for financial assets and financial liabilities. A financial asset or liability could be measured at amortised cost only where it is determined that the instrument has ‘basic loan features’ and the instrument
is managed on a ‘contractual yield basis’.
In short, basic loan features are contractual terms that will trigger cash flows of principal and interest. For example, contractual terms may include returns to the holder that are fixed or variable (or a combination thereof) where interest compensates the issuer for the time value of money and the credit risk assumed.
Financial instruments are managed on a contractual yield basis only when they are monitored by key management personnel of the entity on the basis of their contractual cash flows. For example, trade receivables and payables, general borrowings and debentures would generally be managed on the basis of the interest and principal payments or receipts to which the entity is exposed or entitled.
Financial assets and liabilities measured at fair value.
Unless a financial instrument satisfies the conditions to be measured at amortised cost, the instrument must be measured at fair value. This includes instruments that were previously carried at cost under the existing AASB 139 because they do not have a quoted market price and their fair values cannot be reliably measured. In other words, the ‘cost-exemption’ will no longer be available.
Subject to a couple of exceptions, changes in fair value shall be recognized through the income statement and so this will introduce a greater degree of volatility
in reported earnings than is currently the case.
The exceptions to this rule are:
- the instrument has been designated in a hedging relationship; or
- the instrument is an investment in an equity instrument where fair value changes have been designated through other comprehensive income. Such investments cannot be held for trading purposes.
It is thought that entities will be attracted to coupling an equity investment to their statement of OCI where the investment is held for strategic reasons as opposed to the generation of capital and/or revenue gains.
Another attraction with such a classification will be the ability to essentially do away with impairment testing of such investments. This proved to be a significant area of contention this reporting season under the current AASB 139 where investments whose decline in value below cost was determined as being ‘significant’ or ‘prolonged’ had to take an impairment hit to the income statement.
This will not be an issue for OCI equity investments under the proposals since all fair value movement will be posted through OCI. On the downside of such classification is that any dividends generated on such investments will also be recognised through OCI and not through profit or loss. Listed investment companies may therefore be forced to adopt the ‘fair value through profit or loss’ classification so that their income statement reflects the true nature of their operations with the associated fair value volatility.
There will not be any recycling of gains or losses on disposal of OCI investments through the income statements, and it should also be noted that the OCI designation is an irrevocable election once made.
Benefit of early adoption?
A benefit that is likely to be looked at closely by entities carrying large portfolios of currently impaired available-for-sale (‘AFS’) equity investments would be the ability to classify such assets at fair value with increments in value to be taken to the income statement. This would circumvent the current AASB 139 requirement to book revaluation increments on AFS investments back through an equity reserve despite having just taken impairment charges through the profit and loss in the last reporting period.
Further parts to come
These changes represent phase one of a three phase process. As each phase is completed, the IASB will delete the relevant portions of the current IAS 39 (i.e. AASB 139).
Other phases of the overall project will deal with impairment of financial assets (exposure draft expected to be published in October 2009) and hedge accounting (exposure draft expected to be published in December 2009).
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Article Series
This article is part 1 of a 3 part series. Other articles in this series are shown below:
-
AASB 139 Revised – Part 1 out soon!