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Classification and its importance
All financial assets, including derivatives, are
recognised on the balance sheet under IFRS . They are initially measured
at fair value plus, in the case of a financial asset
not at fair value through profit or loss, transaction
costs that are directly attributable to the acquisition
of the asset [IAS39R.43] . The accounting
treatment of financial assets, subsequent to initial
recognition, depends on how they are classified.
An entity should recognise a financial asset on
its balance sheet, when, and only when, it becomes
a party to the contractual provisions of the instrument
[IAS39R.14] . The purchase or sale
of a financial asset in accordance with the time
frame generally established by market convention
(a 'regular way' transaction), should be recognised
using either trade date or settlement date accounting
[IAS39R.38] [IAS39R.IG.D.2.2.]. The method used
should be applied consistently for all transactions
that belong in the same category of financial assets
[IAS39R.AG53-54] .
Most financial assets, subsequent to initial recognition,
are re-measured to fair value at each balance sheet
date. There are two classes of assets that are carried
at amortised cost subject to a test for impairment.
These are loans and receivables and held-to-maturity
investments. There is also an exception to the fair
value measurement requirement for investments in
equity instruments that do not have a quoted market
price in an active market that cannot be reliably
measured and for derivatives that are linked to
and must be settled by delivery of such unquoted
equity instruments. These instruments are measured
at cost, subject to a test for impairment. This
exception is expected to be used rarely - in most
cases an entity will be able to reliably measure
the fair value of unquoted equity instruments and
derivatives on them [IAS39R.46] .
Categories of financial assets
There are four categories of financial assets:
fair value through profit or loss (which includes
trading), loans and receivables, held-to-maturity
and available-for-sale [IAS39R.45]. All financial
assets not covered in the exclusions in section
80.1 above, must be classified into one of the four
categories. Classification is not necessarily a
free choice but is based on facts and circumstances
and the intent of management at the date of purchase.
Transfers between categories after initial recognition
are restricted.
Financial assets at fair value through profit or loss
A financial asset at fair value through
profit or loss is one that either
| (a) |
is classified as held for trading,
which means that it is |
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(i) |
acquired principally for the purpose
of selling it in the near term ; |
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(ii) |
part of a portfolio of identified financial
instruments that are managed together and
for which there is evidence of a recent actual
pattern of short-term profit-taking; or |
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(iii) |
a derivative (except for one that is
designated and effecting hedging instrument);
or |
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| (b) |
upon initial recognition it is
designated as at fair value through profit or
loss. An entity may use this designation when
doing so results in more relevant information,
because either |
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(i) |
it eliminates or significantly reduces
a measurement or recognition inconsistency (an
'accounting mismatch') that would otherwise
arise from measuring assets or liabilities or
recognising the gains and losses on them on
different bases; or |
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(ii) |
a group of financial assets and/or financial
liabilities is managed and its performance is
evaluated on a fair value basis, in accordance
with a documented risk management or investment
strategy and information about the assets and/
or liabilities is provided internally to the
entity's key management personnel (as defined
in IAS 24). |
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An entity may also use this designation
for a contract that contains one or more embedded
derivatives, unless; |
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(a) |
that embedded derivative does not significantly
modify the cash flows that otherwise would be
required by the contract, or |
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(b) |
it is clear with little or no analysis
that separation of the embedded derivative is
prohibited. |
Subsequent measurement
Financial assets at fair value through profit or
loss are re-measured to fair value at each subsequent
balance sheet date until the assets are de-recognised
[IAS39R.46] . The gains and losses
arising from changes in fair value are included
in the income statement in the period in which they
occur [IAS39R.55]. Gains and losses will include
both realised gains and losses arising on the disposal
of these financial assets and unrealised gains and
losses arising from changes in the fair value of
the assets still held.
Loans and receivables
Loans and receivables are financial assets with
fixed or determinable payments that are not quoted
in an active market, that are not intended for trading,
that are not initially designated as available for
sale or where the holder may not recover substantially
all of its initial investment other than because
of credit deterioration (e.g. interest only strip).
An interest acquired in a pool of assets that are
not loans or receivables (for example, an interest
in a mutual fund or a similar fund) is not a loan
or receivable [IAS39R.9] .
Loan origination fees and costs
Loan origination fees are deferred and recognised
as an adjustment to the effective yield of a loan
[IAS18Appendix.14(a)(i)]. A portfolio basis can
be adopted if it is not possible to adjust the effective
yield on an individual loan basis.
Origination fees are an integral part of generating
an ongoing involvement with the resultant financial
asset, and together with the related direct costs,
are deferred and recognised as an adjustment to
the effective yield, except when the financial asset
is classified as at fair value through profit or
loss [IAS18Appendix.14(a)(i)].
Loan origination costs attributable to unsuccessful
loans are expensed. An entity should therefore have
a system for distinguishing successful from unsuccessful
loans and for determining the related incremental
and directly attributable origination costs.
Transaction costs are incremental costs that are
directly attributable to the acquisition of a financial
asset [IAS39R.9] and include costs such as fees
and commissions paid to agents, advisers, brokers
and dealers; levies by regulatory agencies and securities
exchanges; and transfer taxes and duties. Transaction
costs do not include debt premium or discounts,
financing costs, or internal administrative or holding
costs [IAS39R.AG13].
Subsequent measurement
Loans and receivables are subsequently measured
at amortised cost using the effective interest method,
and are subject to impairment testing (Impairment
of financial assets for banks) [IAS39R.46].
Amortised cost is assumed to approximate the original
invoice amount for short-term receivables with no
stated interest rate if the impact of discounting
would not be significant [IAS39R.AG79].
The effective interest method is a method of calculating
the amortised cost of a financial asset and of allocating
the interest income over the relevant period.
The effective interest rate is the rate that exactly
discounts estimated future cash receipts through
the expected life of the asset or, when appropriate,
a shorter period to its net carrying amount. When
calculating the effective interest rate, an entity
estimates cash flows considering all contractual
terms of the financial instrument (for example,
prepayment, call and similar options) but does not
consider future credit losses [IAS39R.9].
Entities are not permitted to use an expected life
that is longer than the contractual life of the
asset when determining the effective interest rate
as that would take future credit losses (due to
time value) into consideration [IAS39R.9].
Held-to-maturity investments
Held-to-maturity investments are financial assets
with fixed or determinable payments and fixed maturity
that an entity has the positive intention and ability
to hold to maturity [IAS39R.9]
. Fixed or determinable payments
and fixed maturity means a contractual arrangement
that defines the amounts and dates of payments to
the holder, such as interest and principal payments
on debt [IAS39R.AG17]. Floating rate debt is considered
to have determinable payments and can therefore
be included in the held-to-maturity category [IAS39R.AG17].
Held-to-maturity is a restrictive category because
it is an exception from the general requirement
to measure financial assets at fair value. There
are strict criteria that an asset and the entity
must meet before assets can be categorised as held-to-maturity.
IFRS requires 'a positive intent and ability' to
hold a financial asset to maturity. The intent and
ability must be assessed when an asset is acquired
and at each subsequent balance sheet date [IAS39R.AG25]
. A positive intent to hold the
assets is a much higher hurdle than the absence
of intent to sell the asset.
Positive intent cannot be demonstrated if [IAS39R.AG16]:
| a) |
the entity intends to hold
the financial asset for an undefined period; |
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| b) |
the entity stands ready to sell
the financial asset in response to changes in
market interest rates or risks, liquidity needs,
changes in the availability of and the yield
on alternative investments, changes in financing
sources or terms, or changes in foreign currency
risk; or |
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| c) |
the issuer has a right to settle the financial
asset at an amount significantly below its amortised
cost. |
The ability to hold the financial asset to maturity
cannot be demonstrated if the entity [IAS39R.AG23]:
| a) |
does not have the financial
resources available to continue to finance the
investment until maturity ;
or |
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| b) |
is subject to legal or other
constraints that could frustrate its intention
to hold the financial asset to maturity. |
Tainting of held-to-maturity
When an entity's actions cast doubt on its intent
or ability to hold investments to maturity, the
entity is prohibited from using the held-to-maturity
category for a reasonable period of time [IAS39R.AG20]
. A penalty is therefore effectively
imposed for a change in management's intention.
The entity is forced to reclassify all its held-to-maturity
investments as available-for-sale and measure them
at fair value until it is able, through subsequent
actions, to restore faith in its intentions (i.e.
"cleansed") [IAS39R.IG.B.19].
More specifically, an entity shall not classify
any financial assets as held to maturity if it has,
during the current financial year or the two preceding
financial years sold or reclassified more than an
insignificant amount of held-to-maturity investment
before maturity. However, this tainting does not
occur if the sales are: (a) so close to maturity
that changes in the market rate of interest would
not have a significant effect on the financial asset's
fair value; (b) occur after the entity has collected
substantially all of the asset's original principal;
or (c) are attributable to an isolated event that
is beyond the entity's control, is non-recurring
and could not have been reasonably anticipated by
the entity [IAS39R.9].
Tainting affects all assets in the held-to-maturity
category. Segregation of assets into separate portfolios
does not 'protect' assets held in other portfolios
[IAS39R.IG.B.20]. Similarly, holding assets in different
legal entities within one group does not prevent
the tainting of assets held by other entities. Sale
of any held-to-maturity assets will call into question
management's intention and ability to hold all assets
to maturity not just assets of a similar type or
within the same portfolio [IAS39R.9] .
Subsequent measurement
Held-to-maturity assets are subsequently carried
at amortised cost, subject to impairment testing
[IAS39R.46].
Available-for-sale assets
Available-for-sale (AFS) financial assets are those
financial assets that are designated as available
for sale or are not classified as (a) loans and
receivables, (b) held-to-maturity investments or
(c) financial assets at fair value through profit
or loss [IAS39R.9]. Thus, AFS is a residual category.
The AFS category will include all equity securities
except those classified as fair value through profit
or loss.
Subsequent measurement
Available-for-sale financial assets are carried
at fair value subsequent to initial recognition
[IAS39R.46]. There is a presumption that fair value
can be readily determined for most financial assets
either by reference to an active market or by a
reasonable estimation process. The only exemption
to this is equity securities that do not have a
quoted market price in an active market and for
which a reliable fair value cannot be reliably measured
.
Most gains or losses on an available-for-sale financial
asset shall be recognised directly in equity until
the financial asset is derecognised. The cumulative
gain or loss previously recognised in equity is
recognised in profit or loss when the asset is derecognised.
However, impairment losses, foreign exchange gains
and losses (on AFS debt securities) and interest
(on AFS debt investments) calculated using the effective
interest method are recognised in profit or loss.
Dividends on an available-for-sale equity instrument
are recognised in profit or loss when the entity's
right to receive payment is established [IAS39R.55].
Changes in classification of financial assets
Reclassifications between categories are relatively
uncommon in IAS 39 and are prohibited into and out
of the fair value through profit or loss category,
with the exception of the following:
| a) |
derivatives that become part
of a hedging relationship and are therefore
reclassified out of held-for-trading; |
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| b) |
derivatives that are no longer
part of a hedging relationship and are therefore
reclassified into held-for-trading; and |
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| c) |
a portfolio of assets on which there is evidence
that short-term profit-taking has begun, which
should be reclassified into held-for-trading. |
The most common reason for a reclassification out
of the HTM category is when the whole category is
tainted and has to be reclassified as available-for-sale
for two years. In such circumstances the assets
are re-measured to fair value with any difference
recognised in equity.
An instrument may be reclassified into the HTM
category where the tainted held-to-maturity portfolio
has been "cleansed". In this case the
financial asset's carrying value at the date of
reclassification is recharacterised as amortised
cost. Any unrealised gains and losses recognised
in equity remain in equity until the asset is impaired
or derecognised .
Fair value measurement considerations
All assets classified at fair value through profit
or loss (including all derivatives) and available
for sale are measured at fair value. Unquoted equity
investments and derivatives on unquoted equity investments
whose fair value cannot be reliably measured are
not measured at fair value. IAS 39 defines fair
value as the amount for which an asset could be
exchanged or a liability settled, between knowledgeable,
willing parties in an arm's length transaction [IAS39R.9].
The presumption that an entity is a going concern
without any intention or need to liquidate, or to
undertake a transaction on adverse terms underpins
the definition of fair value. Fair value is not
therefore the amount that an entity would receive
or pay in a forced transaction, involuntary liquidation
or distress sale. However, fair value does reflect
the credit quality of the instrument.
There is a general presumption that fair value
can be reliably measured for all financial instruments.
IAS 39R provides the following hierarchy for determining
an instrument's fair value:
Active market - quoted market price: The existence
of published price quotations in an active market
is the best evidence of fair value and, when they
are available, they must be used to measure fair
value . The phrase
"quoted in an active market" means that
quoted prices are readily and regularly available
from an exchange, dealer, broker, industry group,
pricing service or regulatory agency. Those prices
represent actual and regularly occurring market
transactions on an arm's length basis. The price
can be taken from the most favourable market readily
available to the entity even if that was not the
market in which a transaction would occur [IAS39R.AG71].
The quoted market price cannot be adjusted for "blockage"
or "liquidity" factors. The fair value
of a portfolio of financial instruments is the product
of the number of units of each instrument and its
quoted market prices. The appropriate quoted market
price for an asset held or a liability to be issued
is the current bid price and for an asset to be
acquired or liability held, is the asking price.
When an entity has assets and liabilities with offsetting
risk positions, it may use mid-market prices and
apply the bid or asking price to the net open position
as appropriate. When current bid prices are unavailable,
the price of the most recent transaction provides
evidence of the current fair value [IAS39R.AG72].
No active market - valuation techniques: If the
market for a financial instrument is not active,
fair value is established by using a valuation technique.
The objective of a valuation technique is to establish
what the transaction price would have been on the
measurement date in an arm's length transaction
motivated by normal business considerations [IAS39R.AG75].
Valuation techniques that are well established in
financial markets include reference to a transaction
that is substantially the same with adjustment for
the differences, discounted cash flows and option
pricing models. An acceptable valuation technique
incorporates all factors that market participants
would consider in setting a price, and should be
consistent with accepted economic methodologies
for pricing financial instruments. Entities are
also required to periodically calibrate the valuation
technique and test it for validity using prices
from any observable current market transactions
in the same instrument or based on any available
observable market data. An entity obtains market
data consistently in the same market where the instrument
was originated or purchased [IAS39R.AG76]. Normally
the amount paid or received for a financial instrument
is the best estimate of fair value at inception.
However, where all data inputs to a valuation technique
are obtained from observable market transactions,
the resulting calculation of fair value can be used
for initial recognition .
No active market - equity instruments: Normally
it is possible to estimate the fair value of an
equity instrument that an entity has acquired from
an outside party. However, if the range of reasonable
fair value estimates is significant, and no reliable
estimate can be made, an entity is permitted, as
a last resort, to measure the instrument at cost
less impairment. A similar dispensation applies
to derivative financial instruments that can only
be settled by physical delivery of such unquoted
equity instruments.
Day 1 profit recognition: It might be possible
in some circumstances to recognise a gain on initial
recognition of a financial instrument. However,
the circumstances in which this is permitted are
very tightly controlled. Entities will have to demonstrate
that the fair value is evidenced by actual current
market transactions in the same instrument (i.e.
without modification or repackaging) or based on
a valuation technique whose variables include only
observable market data.
Presentation and Disclosure
An entity must disclose the accounting policies
and methods adopted, including the criteria for
recognition and the basis of measurement applied
[IAS32R.60] .
An entity shall present current and non-current
assets as separate classifications on the face of
its balance sheet except when a presentation based
on liquidity provides information that is reliable
and is more relevant [IAS1R.51].
An asset shall be classified as current when it
satisfies any of the following criteria:
| (a) |
it is expected to be realised
in, or is intended for sale or consumption in,
the entity's normal operating cycle; |
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it is held primarily for the purpose
of being traded; |
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it is expected to be realised within twelve
months after the balance sheet date; or |
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it is cash or a cash
equivalent unless it is restricted from being
exchanged or used to settle a liability for
at least twelve months after the balance sheet
date. |
All other assets shall be classified as non-current
[IAS1R.57].
In the notes to the financial statements an entity
must also disclose the information required by IAS
32R.51-94 including the following:
| a) |
risk management and hedging
policies [IAS32R.56] |
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information about the extent
and nature of the financial instruments including
any significant terms and conditions [IAS32R.60] |
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| c) |
information about its exposure to interest
rate risk including contractual repricing or
maturity dates, whichever dates are earlier
and effective interest rates [IAS32R.67] |
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information about
its exposure to credit risk including the amount
that best represents the maximum credit risk
exposure and significant concentrations of credit
risk [IAS32R.76] |
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fair values for
those financial assets not already measured
at fair value [IAS32R.87] |
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methods and significant
assumptions applied in determining fair values
of all financial assets [IAS32R.92] |
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| g) |
details of derecognition
transactions that either fail to qualify for
derecognition or are accounted for using the
continuing involvement approach[IAS32R.94(a)]
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| h) |
details of collateral
pledged and accepted [IAS32R.94(b)] |
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| i) |
details of compound
financial instruments with multiple embedded
derivatives [IAS32.94(d)] |
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| j) |
details about financial assets and financial liabilities designated
at fair value through profit or loss [IAS32R.94(e)-(f)] |
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| k) |
reasons for reclassification
of assets measured at cost or amortised cost
from fair value [IAS32R.94(g)] |
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| l) |
material items of
income and expense and gains and losses from
financial assets [IAS32R.94(h)] |
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| m) |
nature and amount
of any impairment losses [IAS32R.94(i)] |
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