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IFRS 32 and IFRS 39 Financial instruments
International Financial Reporting Standards (IFRS; International Financial Reporting Standards) - a set of documents (standards and interpretations) regulating the rules for the preparation of financial reporting necessary for external users to make economic decisions regarding the enterprise.
IFRS, unlike some national reporting rules, are standards based on principles rather than on rigidly written rules. The goal is that in any practical situation, drafters can follow the spirit of the principles, rather than trying to find loopholes in clearly written rules that would circumvent any basic provisions. Among the principles: the accrual principle, the principle of going concern, prudence, appropriateness and a number of others.
The purpose of this work is to consider in detail IFRS 32 “Financial Instruments - Presentation” and IFRS 39 “Financial Instruments - Recognition and Measurement”.
Financial instruments constitute a significant part of the assets and liabilities of many organizations, especially credit institutions. Financial instruments play a leading role in ensuring the efficient functioning of financial markets. Over the past three decades, the market for financial instruments has grown significantly, both quantitatively and qualitatively; its development was accompanied by the emergence of more and more new types of financial instruments, including derivatives. In modern conditions, banks and companies are not limited to using traditional primary instruments, resorting to complex risk management tools where interrelated financial instruments are actively used.
In response to the development of financial markets, the IFRS Committee developed International Financial Reporting Standards (IAS) 32 and 39. Moreover, in the first draft of the standard on financial instruments, issued in the early 90s of the last century, issues of presentation and disclosure of information on financial instruments were considered together with issues of their recognition and evaluation. Due to their complexity, these questions have been divided into two standards (IAS 32 and IAS 39, respectively). International Standards 32 and 39 have been revised and updated numerous times since their publication.
The differences between standards 32 and 39 are determined by their different scope of application. Thus, IFRS 32 “Financial Instruments: Disclosure and Presentation” considers the classification of financial instruments (into financial assets, financial liabilities and equity instruments), some aspects of the recognition of financial instruments in financial statements (for example, dividing them into a liability element and an equity element), netting of financial instruments and related interest, dividends, profits and losses, and also establishes disclosure requirements for all types of financial instruments and the risks associated with them in the notes to the financial statements. On the contrary, IFRS 39 “Financial Instruments: Recognition and Measurement” addresses the issues of recognition (derecognition) of financial assets and financial liabilities, their classification, the procedure for the initial and subsequent measurement of various groups of financial assets and financial liabilities, as well as the most complex issues - special accounting for hedging.
IFRS 32 Financial Instruments - Presentation
Based on the general situation, the following can be noted:
National Financial Reporting Standard 32 “Financial Instruments: Presentation of Information” (NFRS 32) (hereinafter referred to as the Standard) was developed in order to implement the Main Directions of the Monetary Policy of the Republic of Belarus for 2007, approved by the Decree of the President of the Republic of Belarus dated November 30, 2006.
The requirements established by this Standard are mandatory for execution by the National Bank of the Republic of Belarus, banks and non-bank financial institutions of the Republic of Belarus established in accordance with the legislation (hereinafter referred to as banks).
The purpose of this Standard is to define:
a) requirements applied when classifying financial instruments into financial assets, financial liabilities, and equity instruments;
b) principles for presenting financial instruments as financial liabilities or own equity instruments in financial statements;
c) principles of recognition and presentation in financial statements of interest income, dividends, other income and expenses related to financial instruments;
d) the circumstances under which financial assets and financial liabilities are offset upon recognition.
For the purposes of this Standard, the following terms have the following meanings:
- financial instrument- a security or agreement, as a result of which a financial asset simultaneously arises in one organization and
a financial liability or equity instrument of another entity;
- financial asset- an asset that is:
a) in cash;
b) the right to receive funds or other financial assets from another organization under a security or agreement (hereinafter referred to as the agreement);
c) the right to exchange financial assets or financial liabilities with another organization under an agreement on terms that are favorable to the bank;
d) an equity instrument of another legal entity;
e) an agreement, regardless of whether it is a derivative instrument or not, the settlement of which is carried out or can be carried out by receiving a variable (non-fixed) number of the bank’s own equity instruments;
financial liability- an obligation that is:
The obligation to provide another organization with funds or other financial assets in accordance with the agreement;
The obligation to exchange financial assets or financial liabilities with another organization in accordance with the agreement on terms that are unfavorable for the bank;
An agreement, regardless of whether it is a derivative instrument or not, the settlement of which is or may be carried out by transfer of a variable (non-fixed) number of the bank’s own equity instruments;
equity instrument- an agreement that confirms the right to a share in the capital of a legal entity;
own equity instrument- equity instrument issued by the bank (common (ordinary) and preferred shares);
complex financial instrument- a financial instrument that contains both an element of financial liability and an element of capital;
organization- a general term that includes legal entities (banks, non-banking financial organizations, commercial organizations, non-profit organizations, government bodies), individual entrepreneurs and individuals;
fair value- the amount for which it is possible to exchange assets or settle obligations between knowledgeable parties who are willing to make such a transaction and independent of each other.
This Standard applies to contracts for the purchase or sale of non-financial assets (except for precious metals - for the National Bank of the Republic of Belarus), the settlement of which is made in cash on a net basis or other financial instruments or through the exchange of financial assets and financial liabilities. This Standard does not apply to contracts entered into for the purpose of acquiring and further using non-financial assets.
When recognizing the classification of financial instruments, the following aspects are disclosed:
On initial recognition, the bank classifies a financial instrument as a financial liability, a financial asset or its own equity instrument in accordance with the subject matter of the contract and the definitions of “financial liability”, “financial asset” and “treasury equity instrument”.
It should also be noted that the Bank recognizes, measures and derecognises financial assets and financial liabilities, including complex financial instruments, in accordance with the requirements of IFRS 39.
There are some peculiarities in the presentation of individual financial instruments in financial statements.
Some financial instruments may have the legal form of their own equity instrument but be financial liabilities in economic substance, while others may combine both the characteristics of their own equity instruments and financial liabilities. For such financial instruments, the bank additionally provides relevant information in the notes to the financial statements by disclosing it based not so much on their legal form, but rather on their economic content.
The financial instrument is presented in the financial statements as its own equity instrument.
A financial instrument is a financial liability if the bank is given the opportunity to choose a settlement method: by providing cash or other financial assets, or its own equity instruments, the value of which significantly exceeds the amount of cash or other financial assets.
A financial instrument is a financial liability or a financial asset, respectively, that has a contractual right to receive or an obligation to deliver a variable number of its own equity instruments that have a value equivalent to the amount of the contractual rights or obligations.
A financial instrument is classified as a financial liability if the method of repayment of the financial instrument depends on the outcome of future uncertain events (circumstances) beyond the control of both the issuing bank and the owner of the financial instrument.
When presenting a complex financial instrument, the bank allocates its carrying amount into the elements of financial liability and equity. In this case, the capital element includes the value remaining after deducting the fair value of the financial liability (the fair value of which can be reliably measured) from the value of the complex financial instrument.
When the elements of a complex financial instrument are presented separately in financial statements, income and expenses do not arise.
Income and expenses associated with the issue of a complex financial instrument are presented as elements of a financial liability and equity in proportion to the distribution of proceeds.
The presentation of the elements of a complex financial instrument in the notes to the financial statements remains unchanged until the obligations under it are settled.
When presenting dividends, interest and other income and expenses in the income statement and/or in equity, consideration must be given to the classification and presentation of the financial instrument as a financial liability or an equity instrument. Thus, dividends on preference shares classified as financial liabilities are presented in the income statement.
Income and expenses for the issue, acquisition, repurchase, sale of own equity instruments are presented in capital.
Expenses on transactions in own equity instruments that do not take place are presented in the income statement.
IFRS 39 Financial Instruments - Recognition and Measurement
The purpose of IFRS No. 39 “Financial Instruments: Recognition and Measurement” is to establish principles for the recognition and measurement of financial assets.
Definitions related to recognition and measurement
Amortized cost of a financial asset or financial liability - the amount at which financial assets or liabilities are measured at initial recognition, less principal payments, less the cumulative amortization, using the effective interest method, of any difference between cost and redemption amount, and less the amount of the reduction ( directly or through the use of an allowance account) for impairment or bad debts.
Effective interest rate method - A method of calculating the amortized cost of a financial asset or financial liability (or group of financial assets or financial liabilities) and allocating interest income or interest expense over the relevant period. Effective interest rate- the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, where appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, an entity must calculate the cash flows taking into account all the contractual terms of the financial instrument (for example, prepayment rights, call options and similar options), but must not take into account future credit losses. The calculation includes all fees and amounts paid or received by the parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts.
Derecognition- exclusion of a previously recognized financial asset or financial liability from the balance sheet of an enterprise.
fair value- the amount for which an asset can be exchanged or an obligation fulfilled in a transaction between knowledgeable, willing parties in an independent manner.
Standard procedure for buying or selling- the purchase or sale of a financial asset under a contract whose terms require delivery of the asset within a period of time established by the rules or agreements accepted in the relevant market.
Transaction costs- additional costs directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. Incremental costs are costs that would not have occurred if the entity had not acquired, issued or sold the financial instrument.
Derivative instrument- is a financial instrument or other contract that has the following characteristics: its value is subject to change due to fluctuations in interest rates, security rates, exchange rates, price or rate indexes and other variables; there is no need for initial investment to purchase it; calculations for it will be made in the future.
Requirements for financial assets:
classification by purpose - for sale: acquired for sale or repurchase in the short term; part of a portfolio of identifiable financial instruments; derivative instrument (except if the derivative instrument is a hedging instrument);
Financial assets must be determined on initial recognition at fair value through profit or loss, except for investments in equity instruments for which fair value is not reliably determined.
Embedded derivative is a component of a complex financial instrument that affects cash flows. A derivative that is attached to a financial instrument but is contractually transferred independently of that instrument is not an embedded derivative but a separate financial instrument. Conditions for separating an embedded derivative from the host contract:
The economic characteristics and risks of the embedded derivative are unrelated to the economic characteristics and risks of the host contract;
A separate instrument meets the definition of a derivative instrument.
This standard applies to all types of financial instruments. The exceptions are:
Interests in subsidiaries, associated organizations and joint ventures;
Rights and obligations of employers under employee benefit plans;
Rights and obligations under lease agreements;
Rights and obligations that arose under insurance contracts;
Financial guarantee agreements (including letters of credit and other loan repayment guarantees);
Agreements on contingent consideration in business combinations;
Contracts containing a requirement to make payments that depend on climatic and geological variables;
Loan obligations that are not settled by offsetting counterclaims in cash or other financial instruments.
Based on the above, we can conclude that correctly accounting for financial instruments is not a simple task that requires the development of a certain approach and thinking. In order to reflect a particular financial instrument, it is necessary to understand the nature of the financial instrument and the purpose for which it was acquired.
WITHlist of used literature
financial international reporting standard
1. Electronic source of the Internet - be5.biz;
2. Electronic source of the Internet - pravobi.info;
3. Electronic source of the Internet - ru.wikipedia.org;
4. Electronic source of the Internet - base.consultant.ru;
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IFRS 32 and 39 apply to all financial instruments except:
§ interests in subsidiaries and associated companies, as well as in joint ventures, which are accounted for in accordance with IFRS 27 “Consolidated and Individual Financial Statements”, IFRS 28 “Investments in Associates” and IFRS 31 “Joint Arrangements”;
§ rights and obligations under leases to which IFRS 17 Leases applies; however, rent receivable recognized on the lessor's balance sheet is subject to IAS 39's consideration of derecognition;
§ rights and obligations under insurance contracts, except for financial instruments that take the form of insurance contracts (or reinsurance contracts), but under which a significant share of financial risks is transferred, as well as derivative instruments embedded in insurance contracts, to which the provisions of IFRS 39 apply;
§ assets and liabilities of employers under pension plans to which IFRS 19 “Employee Benefits” applies;
§ financial guarantee agreements, including letters of credit, which provide for payments in the event that the debtor is unable to make timely payment;
§ agreements during the merger of companies that provide for compensation based on future events.
Definitions
Financial instrument is any contract that simultaneously creates a financial asset for one company and a financial liability or equity instrument for another.
Financial asset is any asset that is:
§ in cash;
§ the right to claim funds or other financial assets from another company under a contract;
§ the contractual right to exchange financial instruments with another company on potentially favorable terms;
§ an equity instrument of another company;
§ contracts in which the bank uses its own equity instruments as the means of payment under the contract for the purpose of receiving or providing a different number of shares, the value of which is fixed or equal to an amount determined on the basis of changes in the underlying variable.
Financial obligation is any obligation that is:
§ a contractual obligation to provide funds or other financial asset to another company or to exchange financial assets or financial liabilities with another company on potentially unfavorable terms;
§ an agreement for which the means of payment will or may be the bank's own equity instruments, if the agreement is either a non-derivative instrument under which the bank may have an obligation to provide a varying number of its own equity instruments, or a derivative instrument that will be settled in some way, other than exchanging a fixed number of financial assets for a fixed number of own equity instruments.
Equity instrument- is any agreement confirming the right to the share of a company's assets remaining after deducting all its liabilities.
fair value- an amount of funds sufficient to purchase an asset or fulfill a liability when making a transaction between well-informed parties who really want to complete such a transaction and independent of each other.
Derivative instrument is a financial instrument that meets the following conditions:
§ its value changes as a result of a change in an interest rate, the value of a security, the price of a commodity, an exchange rate, an index of prices or rates, a credit rating or credit index, or another variable (sometimes called an “underlying”);
§ its acquisition requires a small initial investment compared to other contracts, the rate of which reacts in a similar way to changes in market conditions;
§ calculations for it are carried out in the future.
Classification of financial assets
According to IAS 39, financial assets must be included in one of the following categories:
1. financial assets measured at fair value with changes in fair value recognized as profit or loss;
2. financial assets available for sale;
3. loans and receivables;
4. investments held to maturity.
The category of financial assets measured at fair value through profit or loss includes two subcategories. The first includes any financial asset that is accounted for upon initial recognition as a financial asset that is measured at fair value with changes in fair value recognized as profit or loss. The second category includes financial assets held for trading. All derivatives (other than those classified as hedging instruments) and financial assets that are purchased or held for sale in the near future or that have recent transactions that indicate an expectation of profit in the short term are financial assets held for trading.
Available-for-sale financial assets includes any non-derivative financial instruments that are classified on initial recognition as available-for-sale financial assets. Available-for-sale financial assets are recognized in the balance sheet at fair value. Changes in fair value are recognized directly in equity in the statement of changes in equity, excluding interest on available-for-sale financial assets, impairment losses and foreign exchange differences. Any resulting gains or losses recognized in equity are recognized as profit or loss on derecognition of the available-for-sale financial asset.
Loans and receivables Non-derivative financial assets with fixed or determinable payments are considered issued or received if they are not quoted in an active market, are not held for trading and are not classified on initial recognition as assets measured at fair value through profit or loss, or available for sale. Loans and receivables for which the owner cannot recover substantially all of the original investment, unless due to a deterioration in credit quality, are classified as available for sale. Loans and receivables are stated at amortized cost.
Investments held to maturity- financial assets with fixed or determinable payments that the bank has the intention and ability to hold to maturity, unless they meet the definition of loans and receivables and unless they are classified at initial recognition as assets measured at fair value with changes in fair value recognized. as profit or loss or available for sale.
Investments held to maturity are stated at amortized cost.
If, during the current financial year or two previous financial years, the bank sold a portion of its held-to-maturity investments (other than a sale of an insignificant amount or a sale due to a special event of an extraordinary nature that the bank could not have prevented), all other held-to-maturity investments of the bank must classified as available for sale.
Objective of IFRS No. 32 Financial Instruments: Disclosure and Presentation is the understanding by users of financial statements of the meaning of financial instruments.
Financial instrument- an agreement as a result of which a financial asset simultaneously arises in one organization and a financial liability in another.
Financial assets include:
- equity instrument of another entity;
- contractual right to receive funds from another organization, to exchange financial assets and liabilities;
- an agreement under which settlement is made using the entity's own equity instruments.
This standard does not apply to the following types of financial instruments:
- the rights and obligations of employers under the workers' compensation program;
- interests in subsidiaries, associated organizations and joint ventures;
- rights and obligations under insurance contracts;
- contracts that provide for payments related to climatic, geographic and physical variables.
This standard applies to recognized and unrecognized financial instruments (loan liabilities).
Equity instrument- an agreement that confirms the right to a residual share in the assets of an organization remaining after deducting all its liabilities.
fair value- the amount for which an asset can be exchanged in a transaction between knowledgeable and independent parties.
IFRS No. 32 Financial Instruments: Disclosure and Presentation applies to contracts for the purchase of financial assets, settlements for which are made by offsetting counterclaims in cash, through the exchange of financial instruments. The exception is contracts for the supply of a non-financial asset to meet the needs of the organization.
Options for settlements under contracts for the purchase of financial assets, settlements for which are made by offsetting counterclaims in cash, by exchanging financial instruments:
- when an organization has a practice of selling the underlying asset in order to profit from price fluctuations;
- the terms of the agreement enable each party to offset counterclaims in cash or by exchanging financial instruments;
- the absence in the agreement of a direct indication of the possibility of settlement by offsetting counterclaims, but the organization has practical skills in such agreements;
- A non-financial asset can be converted into cash.
The purpose of IAS 32 is establish the principles according to which financial instruments are presented as liabilities or equity, and the offsetting of financial assets and financial liabilities is carried out. IAS 32 applies to the classification of financial instruments by the issuer of financial assets, financial liabilities and equity instruments; classification of related interest, dividends, losses and other income, as well as the conditions under which financial assets and financial liabilities are subject to offset.
Financial instrument is any contract that simultaneously creates a financial asset for one company and a financial liability or equity instrument for another.
Financial asset is any asset that represents:
a) cash;
b) an equity instrument of another company;
c) contract law
to receive cash or another financial asset from another company or to exchange financial assets or financial liabilities with another company on potentially favorable terms;
d) such a contract which will or may be settled in the company's own equity instruments and which is:
– a non-derivative instrument for which the entity has or may become obligated to receive a variable number of its own equity instruments;
– a derivative that will or may be settled in any manner other than by exchanging a fixed amount of cash or other financial asset for a fixed number of the entity's own equity instruments. That is why a company's own equity instruments do not include instruments that are themselves contracts to receive or provide the company's own equity instruments in the future.
Financial obligation is any obligation that represents:
a) contractual obligation
provide cash or other financial asset to another company or exchange financial assets or financial liabilities with another company on potentially unfavorable terms;
b) such a contract which will or may be settled in the company's own equity instruments and which is:
– a non-derivative instrument for which the entity has or may become obligated to deliver a variable number of its own equity instruments;
– that derivative instrument which will or may be settled in any manner other than by exchanging a fixed amount of cash or other financial asset for a fixed number of the entity's own equity instruments. That is why a company's own equity instruments do not include instruments that are themselves contracts to receive or provide the company's own equity instruments in the future.
Equity instrument is any contract that confirms the right to a residual interest in the assets of a company remaining after deducting all its liabilities.
Resaleable instrument is a financial instrument that gives the holder the right to sell the instrument back to its issuer for cash or other financial assets, or that is automatically returned to its holder upon the occurrence of an uncertain future event, the death or retirement of the instrument holder.
The issuer of a financial instrument must, on initial recognition, classify the instrument or its constituent parts as a financial liability, a financial asset or an equity instrument, in accordance with the content of the contract and the definitions of a financial liability, a financial asset and an equity instrument.
A financial asset and a financial liability must be offset, and the statement of financial position shall report the net amount, if and only if the entity
a) has a currently legally enforceable right to set off recognized amounts, and
b) intends to settle on a net basis or to realize the asset and satisfy the liability simultaneously.
When accounting for a transfer of a financial asset that does not qualify for derecognition, an entity shall not offset the transferred asset against the corresponding liability.
IAS 32 requires financial assets and financial liabilities to be reported on a net basis when this reflects the entity's expected future cash flows from two or more separate financial instruments. When an entity has the right and intention to receive or pay a net amount, it essentially has only one financial asset or one financial liability. In other cases, financial assets and financial liabilities are presented separately according to their characteristics as assets or liabilities of the entity.
On initial recognition of a financial instrument on the balance sheet, according to IAS 32, the issuer of the financial instrument must classify it (or its elements) based on the content of the contract as either a liability or equity. At the same time, as mentioned above, some financial instruments have the legal form of an equity instrument, but are essentially liabilities.
If a financial instrument does not contain a contractual obligation by the issuer to transfer funds (another financial asset) or exchange the instrument for another on potentially unfavorable terms, then it is an equity instrument. In addition, an equity instrument may be a derivative instrument (swap, warrant), which will be repaid by the issuer by exchanging a fixed amount of cash or a financial asset for a fixed number of its own equity instruments.
Many financial instruments, especially derivatives, often contain both the right and the obligation to exchange them. Such rights and obligations, in accordance with Standard 32, should also be reflected simultaneously in both assets and liabilities of the balance sheet. For example, in a forward contract, one party promises to pay $200,000 in 90 days, and the other party promises to provide $200,000 worth of bonds at the interest rate fixed at the date of the contract. Each party hopes for a change in market prices for bonds in its favor. The buyer and seller have both obligations to transfer and rights to receive the relevant financial instrument on fixed terms. Rights and obligations under such derivative instruments must be reflected separately in the balance sheet.
A financial asset and a financial liability can only be offset under certain circumstances:
- if there is a legally established right (for example, in an agreement), to offset financial assets recognized in the balance sheet against financial liabilities;
- if the company has the ability and intention to make settlements in pursuance of the transaction for the balance amount of mutually opposite financial instruments;
- when the company intends to simultaneously realize a financial asset and pay off financial liabilities, and this intention is feasible in the current circumstances of the transactions.
Offsetting is possible for accounts receivable and payable or bank accounts with debit and credit balances.
If, in accordance with the established requirements, the issuer classifies a financial instrument issued by it as a financial liability, then the interest, dividends, losses and profits relating to it should be reflected in the income statement as expenses or income.
Expenses incurred by the issuer in the form of interest and dividends on equity instruments are charged directly to the debit of the capital account.
Interest (dividends) on preferred shares, which are inherently a financial liability, are accounted for as an expense rather than as a distribution of profits. Such dividends are recognized in the income statement separately from dividends on equity instruments.
The issuer of a complex financial instrument containing both a liability and an equity element must classify the component parts of the instrument separately. Such a complex financial instrument for the issuer could be, for example, a bond convertible into ordinary shares. This instrument consists of two elements: a financial liability (a contractual agreement to provide cash or other financial assets) and an equity instrument (a call option that gives the bondholder the right, within a specified period of time, to convert the instrument into ordinary shares issued by the issuer).
One of two methods can be used to calculate the carrying amount of complex financial instruments.
- Allocating to a more difficult to value equity instrument the amount remaining after deducting the value of the liability from the value of the entire instrument. Thus, the carrying amount of a financial liability is first determined by discounting the stream of future interest and principal payments at the prevailing market interest rate for a similar liability. The remainder attributable to the equity instrument (the option to convert into ordinary shares) is determined by subtracting the value of the financial liability from the value of the compound instrument.
- Valuing the liability element and the equity element separately and resolving them to be equivalent to the value of the instrument as a whole. This method requires the use of complex option pricing models, such as the Black-Scholes model.
EXAMPLE
On January 1, 2000, the company issues 2,000 convertible bonds with a par value of $1,000. Interest is paid annually at a nominal interest rate of 6%. The prevailing market interest rate on the date of issue of the bonds was 9%. The bonds are due to be repaid on December 31, 2002.
Let's determine the value at which the bonds will be reflected in the company's financial statements upon initial recognition using the first method.
1. Current value of the principal amount of debt to be repaid in 3 years:
2000 x $1000 x (1: (1 + 0.09)3 = 2,000,000 x 0.772 = $544,000.
2. Present value of interest: 2,000,000 x 0.06 x 2.531 (cumulative discount rate over 3 years) = $303,720.
Cumulative rate = 1: (1 + 0.09)1 + 1: (1 + 0.09)2 + 1: (1 + 0.09)3 = 2,531.
3. Total liability component: $1,544,000 + 303,720 = $1,847,720.
4. The par value of the issued bonds is 2000 x 1000 = $2,000,000.
5. Capital component (as the difference between the par value of the issued obligations and the liability component) = $152,280.
Therefore, the issuer must report convertible bonds at initial recognition as follows: the obligation to repay the bond (shown as liabilities) in the amount of $1,847,720 and the option to convert (shown in equity) in the amount of $152,280.
When the method of settlement of a financial instrument depends on the outcome of future uncertain events beyond the control of the issuer, the instrument must be classified as a liability.
For example, a company issues bonds that it promises to repay in shares if the market price of the bonds exceeds a certain level. Another example: a company issues shares, the terms of redemption of which depend on the level of its future income (if the company does not achieve a certain level of income by a certain point in time, then it undertakes to exchange its shares for bonds), etc.
IFRS 32 pays considerable attention to the issues of disclosing information about the financial instruments it uses in its financial statements. Such disclosure (partly mandatory, and partly recommended) is necessary for users of financial statements to understand the impact of on-balance sheet and off-balance sheet financial instruments on the financial position of the company, the results of its operations, and the movement of its cash flows.
Companies are encouraged to disclose information about the significance of financial instruments in their activities, the risks associated with them and their controls, and the business interests that these financial instruments serve. It is recommended to disclose the following types of risks associated with financial instruments:
- currency risk (associated with changes in foreign currency exchange rates);
- interest rate risk (associated with changes in interest rates);
- market risk (associated with changes in market prices);
- credit risk (or risk of bad debt);
- liquidity risk or cash risk (the risk that a company will be unable to meet its obligations), cash flow risk (for example, the risk associated with floating rate debt instruments).
IFRS 32 encourages companies to disclose the information above in addition to what the company is required to disclose.
The company must necessarily disclose its goals and policies for managing financial risks, including the hedging policy for the main types of transactions for which it is used. For each class of financial assets, financial liabilities and equity instruments, whether recognized or not, the following must be disclosed in the notes to the financial statements:
- information about the value and nature of financial instruments;
- conditions that may affect the magnitude of future cash flows, their direction and distribution over time;
- accounting policies and methods for recognizing instruments on the balance sheet, as well as methods for valuing financial instruments (for example, for financial instruments carried at fair value, the carrying amount may be determined based on quoted market prices, independent estimates, discounted future cash flow analysis or other methods, which should be disclosed in the notes to the financial statements).
In cases where financial instruments have a significant impact on the financial position of the company, their contractual terms should also be disclosed, for example:
- details of the principal or nominal amount on which future payments are based;
- the date of payment due date, expiration of the contract or the deadline for its execution;
- the rights of the parties to early execution of a transaction on a financial instrument;
- rights to convert a financial instrument, the amounts and timing of future cash receipts and payments, interest rates or dividends;
- the existence and amount of collateral held or granted.
If the presentation of a financial instrument on the balance sheet differs from its legal form, the company must explain the nature of the instrument in the notes to the financial statements. In addition, disclosure of the structure of complex derivatives is required.
Required disclosures include information about the existence of interest rate risk, including contractual repricing or maturity dates and the effective interest rates used (if the appropriate method is used).
If there are a significant number of financial instruments exposed to interest rate risk, they can be grouped by maturity (changes in their price (book value)) in the periods following the reporting date:
- within 1 year;
- separately by period for each year for 1-5 years;
- more than 5 years.
Information about the company's exposure to credit risk must be disclosed, including:
- the size of the maximum credit risk per borrower, excluding the value of collateral;
- presence of significant concentrations of credit risk.
In the reporting of commercial banks, this requirement is reflected in the form of relevant standards.
Recognition and measurement of financial assets and liabilities in IFRS 39, comparison with Russian practice
A company's financial assets and liabilities are recognized (recorded) on its balance sheet only when the company enters into a contractual relationship with another party for those financial instruments. Planned transactions for which there are no binding contractual arrangements at the reporting date cannot be recognized in the company's balance sheet.
From this rule it follows that all contractual rights and obligations of a company in relation to financial instruments, including those related to derivative instruments, must be recognized on its balance sheet as assets or liabilities.
In cases where we are not talking about financial instruments, but about firm agreements for the purchase or sale of goods or services, the entry of two or more companies into contractual relations with each other is a necessary, but not sufficient condition for the recognition of assets or liabilities in the balance sheets of these companies . For such recognition, it is necessary for at least one of the parties to perform the appropriate actions under the contract (payment for goods or services or shipment of goods and provision of services).
An exception is a forward contract, in which the recognition of assets or liabilities in the balance sheets of companies that have entered into such an agreement occurs until the moment of action under the contract. A forward contract is, as stated above, a commitment by one party to buy or sell to another party a financial instrument or commodity at a specified date in the future at a predetermined price. This liability, according to IAS 39, is recognized as an asset or liability on the date the obligation to purchase or sell arises, and not on the date it is settled (the exchange actually occurs). When concluding a forward contract, the fair value of the rights of claim (delivery of an instrument or product) and obligations (to pay it in a fixed amount) often coincide for both parties, so the net value of the forward contract is zero. Assets and liabilities are recognized in the balance sheets of both the buyer and the seller at the time the contract is concluded in the same amounts, even if the net value of the contract is zero. Moreover, each party to the contract is exposed to price risk, which is the subject of the contract. Over time, the fair value of the contract may become a net asset or liability. This depends on various factors, including: changes in the value of money over time, the exchange rate of the underlying instrument or the price of the commodity that is the subject of the forward contract, and others.
If the purchase of financial assets by a company is of a regular nature (i.e., it is a so-called standard transaction), then, in accordance with IFRS 39, the acquired financial assets are allowed to be recognized in the balance sheet both on the date of the transaction and on the date of settlement. The procedure for recognizing financial assets selected and recorded in the accounting policy must be applied throughout the entire reporting period. In this case, the transaction date is the day when the organization assumes an obligation to purchase a certain financial asset. On this day, the financial instrument to be received (in an asset) and the obligation to pay for it (in a liability) are recognized in accounting (and, accordingly, in the balance sheet).
The settlement date is the day on which the financial instrument stipulated by the contract was actually transferred to the organization. In this case, the asset is recognized in the balance sheet at the fair value established for the period from the date of the transaction to the date of recognition of this financial instrument in accounting.
Transactions on sales of financial assets, even those of a regular nature, are allowed to be recognized in accounting and reporting only on the date of settlement.
Derecognition of a financial asset (or part of it) should occur when the entity loses control over the contractual rights that form the content of the financial asset. This may occur when the contractual terms are fulfilled by the counterparty, the rights of claim expire, or the company waives its rights in relation to a given financial asset.
When control of an asset is transferred, it is considered sold. However, if the transfer of an asset does not involve derecognition (i.e. it continues to be held on the company's balance sheet), then the company transferring the asset records the transaction as a secured loan.
A financial asset that is derecognised from the balance sheet must be written down at its carrying amount. The difference between the carrying amount of an asset (or part of an asset) transferred to another party and the amount received (or receivable) for that asset, plus any revaluation of the asset to its fair value (previously recognized in equity) is recorded in profit and loss account.
In some cases, a company may not sell the entire asset, but only part of it, for example, either the principal amount of a debt or interest on bonds. Another example is the sale of a portfolio of receivables while retaining the right to profitably service the debt for a fee, resulting in the servicing right being recognized as an asset (the right to service loans is an intangible asset under IAS 38).
If an entity transfers part of a financial asset to others while retaining another part, the carrying amount of the financial asset should be allocated between the remainder and the part sold in proportion to the fair value of the related items on the date of sale. Profit or loss must be recognized based on the proceeds of the portion sold. In those rare cases where the fair value of the remaining portion of an asset cannot be determined reliably, it is not determined at all and is assumed to be zero. The full carrying amount of the financial asset is assigned to the part sold. Gain or loss is recognized as the difference between revenue and the total (before sale of part) carrying amount of the financial asset, adjusted by the amount previously written off to equity for its revaluation at fair value.
A company should write off a financial liability from its balance sheet (derecognize it) when it is repaid, i.e. fulfilled (the debtor has paid the creditor), canceled legally (either in court or by the creditor itself) or its validity period (established statutory limitation period) has expired. In addition, cancellation is considered to be the replacement of an existing obligation with another obligation with significantly different conditions.
If the borrower and the lender exchange any debt instruments with significantly different terms from the previous agreement, then, according to IAS 39, this fact should be qualified as the repayment of the old debt and the recognition of a new financial instrument.
The difference between the carrying amount of a liability (or part of a liability) extinguished or transferred to another party, taking into account accumulated amortization, and the amount of repayment should be included in net profit or loss for the reporting period.
In accordance with IAS 39, financial assets and financial liabilities are initially measured at cost, which is assumed to be the fair value of the consideration paid (received) for them. Costs incurred in completing the transaction are included in the initial cost of the financial instrument.
The issuance or acquisition of equity instruments generally involves associated costs (registration fees and other regulatory fees; amounts paid to lawyers, accountants, professional advisors; printing costs, etc.) that are charged directly to the reduction of equity. Costs incurred for capital transactions, which for some reason could not be carried out, should be charged to expenses of the current period (in the income statement).
The initial cost of a financial instrument measured at fair value deviates from it in one direction or another over time under the influence of market and other factors. At the same time, fair value can be determined quite accurately if there is a published price of a financial instrument on the open market (market price is the best analogue of fair value); the debt instrument has a rating assigned by an independent rating agency; when using special models, the initial data for the implementation of which is obtained from active markets (for example, the Black-Scholes model). It is not difficult to determine the fair value of a financial instrument even when the range of values of estimated indicators of its value is insignificant.
If market prices are difficult to reliably determine, fair value is determined by other generally accepted methods (by discounting future cash payments or receipts using prevailing market interest rates for similar instruments, price-to-earnings ratios and other methods).
The subsequent measurement of financial assets depends on their actual classification into the four categories discussed in section 4.1. After initial recognition, assets are measured either at fair value or at amortized costs (cost) (Table 1).
Table 1. Reflection and subsequent (after initial recognition) measurement of financial instruments in accounting and reporting
| Types of financial instruments | Loans and receivables not held for trading | Investments held to maturity | Available-for-sale financial assets | Financial assets or liabilities at fair value through profit or loss |
| Reflection in reporting | ||||
| Reflection in accounting | ||||
These rules do not apply to financial instruments used as hedging instruments.
Let us consider in more detail, based on the above diagram, how transactions with various types of financial assets are reflected in accounting.
Under IAS 39, investments, other than held-to-maturity investments, are measured at fair value with changes in fair value recognized, depending on the nature of the investment and/or the accounting policy chosen, through profit or loss (in the relevant financial statement) or directly on own funds accounts.
Gains on revaluation of financial assets measured at fair value through profit or loss (held for trading) should be recognized directly in profit or loss for the reporting period.
Available-for-sale assets may include both equity and debt securities, both market-priced and unquoted. Gain (loss) arising on the revaluation of a financial asset carried at fair value (having a market value) is charged to equity in the statement of capital flows. The capital account (the revaluation account for investment securities available for sale) must maintain a gain or loss until the financial asset is sold, redeemed or otherwise disposed of, or until it is determined to be impaired. When such a moment occurs, the resulting profit (loss) will need to be included in the profit or loss of the reporting period.
When equity investments and related derivatives do not have quoted market prices and fair value is otherwise difficult to determine, those available-for-sale instruments should be carried at cost.
For debt securities held for sale, interest calculated using the effective interest method is recognized in the income statement. Dividends on an existing equity instrument are recognized in profit or loss when the entity's right to receive payment is established.
Thus, both groups of financial assets discussed above are accounted for at fair value (both are inherently trading, but have different maturities and are acquired for different purposes).
Depending on the type of financial instruments (debt or equity) included in the above groups, revaluation profit or loss is determined differently. Thus, for shares assessed at fair value (classified in both the first and second groups), the amount of profit or loss will be equal to the difference between the fair value of the financial instrument at the date of revaluation and its book (purchase) value.
For bonds measured at fair value, the amount of gain or loss from revaluation is determined slightly differently: the fair value of the financial instrument at the date of revaluation minus the carrying (purchase) value, and minus the amortization of the premium (or adding the amortization of the discount).
Recall that for debt instruments, fair value is the sum of the present values of all expected future coupon or interest payments on the debt instrument and its par value, discounted at the current effective interest rate (the market rate at the date of revaluation). Amortized cost is the same present value, but obtained by discounting not at the current effective interest rate, but at the original effective interest rate.
In this case, a premium is a negative difference between the par value and the purchase price of securities, and a discount is, accordingly, a positive difference. Premium amortization is defined as the amortized cost of the financial instrument at the end of the previous period minus its amortized cost at the end of the current period. Accordingly, the discount amortization is the amortized cost at the end of the current period minus the amortized cost at the end of the previous period. Thus, both the premium and the discount are gradually (during the period of stay of financial instruments on the credit institution’s balance sheet in one or another of their portfolios) amortized (transferred) to the bank’s income and expenses.
EXAMPLE
On March 1, the credit institution purchased bonds with a nominal value of 10,000 rubles at a price of 10,300 rubles (i.e., the premium paid was 300 rubles), and on March 31, it revalued the securities at fair value, which amounted to 10,450 rubles. The amount of premium depreciation according to calculations for March was 30 rubles.
In the example given, the amount of revaluation of financial assets will be: 10,450 - 10,300 - 30 = 120 rubles (positive revaluation).
The amount of interest (coupon) income on trading debt securities (accounted for at fair value through profit or loss and available for sale) must be calculated taking into account the effective interest rate.
The amount of accrued interest (coupon) income for the period is determined as: coupon interest accrued at the nominal rate, minus premium amortization or plus discount amortization for the period.
In this case, the accrued coupon interest is equal to: the par value of the securities x the annual coupon rate: the number of accrual periods.
If securities are purchased at their face value, then the coupon rate is considered to be equal to the market rate.
When debt financial instruments are purchased at a premium or discount, both coupon and effective interest rates take part in the calculation of interest income.
EXAMPLE
On April 1, 2005, the bank purchased debt trading securities at a price of 110,000 rubles. The par value of the securities is 100,000 rubles. The coupon rate is 12% per annum. On June 31, the bank accrued interest income, while the amortization of the premium for calculations for April - June amounted to 1,300 rubles.
The scheme for calculating interest income on securities can be presented as follows (Table 2).
Since premium amortization is defined as the amortized cost of a financial instrument at the end of the previous period minus its amortized cost at the end of the current period, the amortized cost at the end of the current period can be determined from this definition. It will be equal to 108,700 rubles (110,000 - 1300).
Hence the interest income is equal to: 1700 rubles (3000 - 1300).
On June 31, interest income will be reflected by the posting:
DEBIT - accrued interest receivable - 3000 rubles;
CREDIT - paid premium on trading securities - 1300 rubles;
LOAN - interest income - 1700 rubles.
Table 2. Calculation of interest income and amortized cost of trading securities
Because the definition of financial assets at fair value through profit or loss (i.e., those primarily held for trading) is based on the original purpose for their acquisition, the standard does not permit reclassifications of those assets into other categories or other categories into the same category. . As for financial assets held to maturity and available for sale, they are rarely transferred from one category to another. The most common is the reclassification of held-to-maturity assets as a result of a change in intention or ability to hold them to maturity into the available-for-sale group. In this case, the reclassification of the item is treated as a sale, the entire category of held-to-maturity financial assets is considered “destroyed,” and all other items in the category of held-to-maturity financial assets must be reclassified as available-for-sale for two years. The consequence of this transfer is the revaluation of assets at fair value and the attribution of the resulting difference to equity.
As for derivative financial instruments, they are initially recognized at cost (the cost of their acquisition) and subsequently at fair value. The exception is for derivatives whose underlying position is an unquoted equity instrument and/or whose fair value cannot be reliably measured and is therefore measured at cost until settlement. However, such exceptions should rarely be allowed under IAS 39 because it is assumed that the fair value of the instruments can be obtained using market values of similar instruments or using special models.
To avoid carrying derivatives at fair value, companies often “embed” them into host contracts that are otherwise accounted for (at cost, remeasured using equity accounts). In order to prevent such violations, IFRS requires that an embedded derivative instrument be separated from the host contract and accounted for in accordance with IAS 39, unless the economic parameters of this instrument are not closely related to the corresponding parameters of the host contract.
Financial obligations After initial recognition, an entity must measure at amortized costs. The exception is financial liabilities intended for trading and initially included in this category.
Financial liabilities held for trading include:
- derivative liabilities that are not accounted for as hedging instruments
- obligations of the seller to transfer securities or other financial assets borrowed by the seller in short sales;
- financial obligations undertaken with the intention of redeeming them in the near future;
- financial liabilities that form part of a portfolio of specific instruments that are managed together (are homogeneous) and for which there is evidence that a profit has actually been earned in the most recent short-term period.
As with financial assets, an entity has the right to designate a financial liability as at fair value through profit or loss on initial recognition. There are no restrictions regarding such a voluntary determination, but it cannot be canceled subsequently, i.e. the obligation can no longer be transferred to another category.
Gains (losses) on financial assets and liabilities carried at amortized cost are recognized in the reporting period only when the financial asset or liability is either derecognized (for example, sold) or is impaired, including through amortization.
Thus, depending on the assignment of certain financial assets or liabilities to their individual classification categories, the financial result (profit or loss) of the reporting period also changes.
All assets other than those measured at fair value through profit or loss are subject to impairment. If there is a possibility of impairment, then the company must accrue an allowance for impairment of assets.
When it is probable that a company will not be able to collect the full amount of debt (principal and interest) on loans issued, receivables, and held-to-maturity investments (i.e., assets carried at depreciable cost), the creation of a reserve is similar to the creation of provision for loans discussed in section 4.6, i.e. as the difference between the carrying amount of the asset and the value of future cash flows expected from the use of the asset, discounted at the original effective interest rate. However, cash flows associated with short-term receivables are generally not discounted.
For financial assets in the form of unquoted equity instruments (available for sale) and carried at cost, the amount of the impairment loss is determined as the difference between the carrying amount of the financial asset and the present value of estimated future cash flows calculated using the current market interest rate specified for similar financial assets. Such an impairment loss, with its subsequent possible reduction, is not subject to recovery in the profit and loss accounts, unlike the first case (for a debt instrument available for sale, the recovery of the value of which can be objectively related to an event that occurred after the loss was recognized, the loss can be compensated through the control center).
For financial assets carried at fair value, the amount of impairment must be calculated for those available-for-sale financial assets for which such impairment is recognized directly in equity.
If the fair value of such instruments falls below the initial cost of acquisition, there is a loss. If there is a loss and at the same time facts of impairment of financial assets are revealed (for example, significant financial difficulties of the issuer, violations of contract terms, etc., discussed in section 4.6), the entire amount of loss previously accumulated during the revaluation of this asset and attributed to capital accounts must be included in debit of the profit and loss account of the reporting period.
This loss is the difference between the cost of acquiring the asset (less principal and amortization) and the current fair value less any impairment loss on the asset previously recognized in net profit or loss. However, if in subsequent periods the fair value of impaired debt instruments increases, then the impairment losses are subject to reversal, and the reversed amount is recognized in profit or loss.
Under IFRS, derivative financial instruments, including forward transactions, are measured at fair value through profit or loss. Therefore, derivative financial instruments are not tested for impairment and no provisions are created for them.
The main differences that exist in information disclosure according to Russian and international standards at the moment are as follows.
Since in domestic practice there is still no division of financial liabilities into debt and equity financial instruments, elements of capital calculated according to Russian standards may in some cases not satisfy the requirements for recognizing them as components of capital under IFRS 32 (for example, some types of preferred shares), and should be classified as financial liabilities.
The reporting of Russian banks does not yet distinguish between the concepts of reserves associated with the impairment of assets (for example, a reserve for possible losses on loans or for the impairment of securities, the formation of which is regulated by IFRS 39 and 36) and reserves-liabilities arising, for example, in cases of litigation proceedings or planned restructuring of the organization (regulated by IFRS 37). In the first case, the provision is an adjustment to the carrying amount of the asset, and in the second it represents a liability. Differences in the content of these concepts lead, accordingly, to the use of different methods for their assessment, recognition and disclosure in reporting.
According to IFRS 37, a provision liability is recognized only if three criteria are simultaneously met:
- the entity has a current obligation (legal or constructive) as a result of past events;
- it is probable that an outflow of resources will be required to settle the obligation;
- a reliable estimate of the amount of the liability can be made.
Regulation 232-P does not contain clear criteria for recognizing reserve liabilities and a reserve can be recognized even when the management of a credit institution has an intention, and not a current obligation, to incur expenses, which is contrary to IFRS.
IFRS 39 requires financial assets and financial liabilities to be recognized (that is, shown on the balance sheet) from the time the bank becomes a party to the financial asset/liability contract (or equity instrument). In Russian practice, there are no such requirements and a significant amount of financial assets and liabilities are recorded in off-balance sheet accounts, which in some cases can significantly distort the structure of the bank’s assets and liabilities.
Currently, financial assets and liabilities are reflected by credit institutions in accordance with the Regulation of the Central Bank of the Russian Federation No. 205-P “On the rules of accounting in credit institutions located on the territory of the Russian Federation.” At the same time, only some securities are taken into account at market value (which is the best indicator of fair value). Other financial instruments are accounted for at the cost of their acquisition/issue. This is contrary to IAS 39, which requires fair value to be determined for all categories of financial instruments (at least at initial recognition of the instruments).
The current economic situation in Russia is still characterized by a rather limited volume of financial transactions on the market and the absence of a full-fledged active market for financial instruments. In this regard, determining the fair value of financial instruments is often difficult for banks. In addition, even in the organized securities market that exists today in Russia, market quotations may not reflect the fair value of financial instruments that could be determined in the markets of developed countries. In this situation, credit institutions may be able to manipulate the value of financial instruments and, most importantly, the value of their equity capital (including revaluation items of certain assets accounted for at fair value). It should also be taken into account that banks have relative freedom as to whether changes in the fair value of financial assets will be recognized in the income statement or as part of shareholders' equity. This may affect the comparability of the financial statements of different credit institutions.
Thus, the application of the concept of “fair value” and the reliability of its assessment are quite problematic in Russian conditions today.
Hedging (hedged items and hedging instruments)
In IFRS 39 under hedging refers to the use of derivatives and, in some cases, non-derivative financial instruments to offset part or all of the changes in fair value or cash flows of the hedged items, i.e. the protected financial instruments. Such changes can arise for various reasons: under the influence of market conditions, exchange rate fluctuations, as a result of changes in the financial position of counterparties and other objective factors.
Hedged item may be any asset or liability recognized on the balance sheet, a firm commitment, agreements not yet entered into and transactions with a high probability of their completion, a net investment in a foreign company, or a group of the above items.
Thus, not only financial, but also non-financial assets (liabilities) can be hedged (protected) items. The latter are usually protected either from currency risks or from aggregate risks in general, since establishing the impact of currency risks is not as difficult as the impact of a large number of other types of risks.
Although loans and receivables and held-to-maturity investments are treated the same (at amortized cost), the former can be hedged against interest rate risk while the latter cannot. This is because classification of an investment as held-to-maturity implies that it is held to maturity regardless of changes in the fair value of the investment itself or its cash flows, which in turn are associated with changes in interest rates. Investments held to maturity can be hedged against currency and credit risks.
Assets (liabilities) with the same level of risk for hedging purposes can be combined into appropriate groups. In this case, only those of the above-listed objects that arise as a result of relations with a party external to the organization hedging the risks are subject to hedging.
Hedging instrument is a specified derivative or (in a limited number of cases) other financial asset or liability whose fair value or cash flows are expected to offset changes in the fair value or cash flows of the specified hedged item. Losses on the hedged item are offset to some extent by gains from changes in the fair value of the hedging instrument. Both of them are reflected simultaneously and in the same amount in the profit and loss account. As a result, the result of hedging is revealed - net losses or net gains on the transaction.
Most derivative financial instruments, except options, can act as hedging instruments. The latter can be used for these purposes only when the sale of one option is combined with the purchase of another (even one embedded in a non-derivative financial instrument).
Derivative financial instruments are almost always carried on the balance sheet at fair value, while non-derivative financial instruments can be carried at both fair value and amortized costs. If the fair value of a financial asset or liability cannot be determined reliably, it is not permitted to be used as a hedging instrument. The exceptions are those non-derivative instruments carried at amortized cost that are denominated in a foreign currency. They can be used to hedge the currency risk of the entire instrument or the currency element of a non-derivative that can be reliably measured. If these instruments are measured at fair value, then changes in it, as is known, are reflected in the capital account.
The advantage of hedge accounting is that gains and losses on any component of the hedge until the end of the hedge can be recognized in equity rather than in the income statement. This eliminates the impact of market fluctuations in such components on the income statement over the life of the hedge. Only at the end of the hedge period is the net gain or loss included in the income statement.
An entity cannot use its own equity securities as hedging instruments because they are not financial assets or financial liabilities of the entity.
Hedging effectiveness is the extent to which the hedging instrument will offset potential changes in fair value or cash flows attributable to the risk being hedged. Moreover, the success of hedging is determined not by the absolute value of the profit that the hedge brings, but by the extent to which this profit compensates for the financial result of the hedged item.
The standard identifies three main hedged item: fair value hedge; cash flow hedges and hedges of net investments in foreign companies. However, hedging transactions can only be carried out when the following certain conditions are met (hedging rules, called hedge accounting):
- the company's risk management objectives and hedging strategy are set out in the company's official documentation;
- hedging is used only when there is a high probability of its effectiveness (the estimated profitability of hedging is from 80 to 125%), and this effectiveness can be assessed with a sufficient degree of reliability;
- ineffectiveness of hedging transactions is recognized immediately in profit or loss;
- there is a high probability of a transaction with a high risk of changes in cash flows that is subject to hedging;
- regular assessment of hedging should confirm its high effectiveness throughout the reporting period;
- Hedged items must meet the definitions of assets and liabilities to be recognized on the balance sheet.
Hedging of transactions carried out within a group of companies is not permitted, since internal transactions are eliminated during consolidation, leaving the company dealing with itself. However, where intragroup hedging transactions are used as a means of entering the market through an intercompany treasury center, IAS 39 provides specific guidance on what needs to be done to properly account for the hedge.
Hedging may also be carried out not in accordance with hedging rules (i.e., without taking into account special requirements and hedging conditions). However, in such situations, the company must record any resulting gains or losses directly in the income statement rather than in equity, which is only permitted under hedge accounting.
A hedging instrument is not derecognised when it is rolled over or when one hedging instrument is replaced by another. But this must be declared in the organization's documented hedging methodology.
Fair value hedges is carried out to protect against losses that may arise when the fair value of an asset (liability) recognized in the balance sheet or its certain share, or an unrecognized firm agreement (share) changes. The financial result (gain or loss) on the revaluation of a hedging instrument carried at fair value must be recognized immediately in profit or loss. The same applies to the financial result arising from the revaluation of the hedged item, which is always charged to the profit and loss account, even if under normal conditions (not during a hedge) changes in the fair value measurement are written off to equity or the item is generally measured at actual costs . How a fair value hedge is implemented is shown in the example.
EXAMPLE
On June 30, 2004, a commercial bank issued debt instruments for $10,000,000 at a fixed interest rate of 7.5% per annum (for a period of 6 months). At the same time, the bank is concerned about possible changes in the value of the obligation, so on the same day it entered into an interest rate swap agreement. A swap contract is a type of forward contract in which the parties agree to make a series of future exchanges of amounts of money, one calculated using a floating interest rate and the other using a fixed interest rate. (Each party hopes that market conditions will be favorable to it.)
Thus, the bank now deals with variable rates. As the rate of return in the market changes, the fair value of the fixed rate debt instrument and the value of the swap will change. You can consider them as one synthetic instrument (debt + swap). At the same time, the company's cash flows change depending on the influence of the market on this instrument, but its total value remains unchanged.
The fair value of the liability from July 1 to December 31 was $10,125,000, i.e., it increased (because the liability was in demand in the market). In the same period, the LIBOR rate (i.e., market interest rate - floating, negotiated) was 6%.
The difference between the original cost of the debt obligation of $10,000,000 and its cost of $10,125,000 = $125,000 is the fair value of the swap, which is an asset because it gives the bank the right to pay 6% per annum for 7.5% (exchange of assets on favorable terms ).
Thus, when the payment deadline arrives, the payment exchange scheme will look like this (Fig. 1).
Fig.1. Payment exchange scheme between the bank, the buyer of its obligations and the party to the swap transaction
The bank's cash flows will look like this (Table 3).
Table 3. Calculation of the bank’s cash flows when hedging the fair value of debt instruments issued by it
The reflection of the hedging transaction discussed above using a swap transaction is presented in the form of a double entry in Fig. 2.
Fig.2. Recording hedging transactions using a swap transaction as a double entry
Thus, the bank paid the creditor on its debt obligations in the amount of $375,000 for only $300,000, i.e., it had an outflow of funds in the amount of only $300,000, and $75,000 was offset by the swap transaction.
Cash flow hedging- this is a hedge of specific risks associated, for example, with future interest payments on a debt obligation with a variable interest rate or with an expected purchase or sale transaction, etc.
If the hedging conditions are met throughout the reporting period, the standard assumes that the profit (loss) on the hedging instrument is divided into two parts. A portion is allocated to a hedging instrument whose effectiveness has been established (confirmed by calculations of effectiveness) and is charged to equity accounts in the statement of changes in equity. The part of the adjustment amount not confirmed by efficiency calculations is written off to the profit and loss account.
The effective portion attributable to equity is determined as the lesser of the cumulative gain or loss on the hedging instrument accumulated since the inception of the hedge or the cumulative change in the fair (discounted) value of the expected cash flows of the hedged item since the inception of the hedge. The remaining gain or loss on a hedging instrument that is not effectively hedged is recognized in profit or loss.
However, there are no rules for assessing effectiveness and ineffectiveness. The decision on this issue must be made by the company. The methodology should be set out in the formal hedging documentation. In practice, this technique can be quite complex.
If a hedge of a forecast transaction results in the recognition of a non-financial asset or non-financial liability on the balance sheet, or the forecast transaction of a non-financial asset (liability) takes the form of a firm agreement that meets the requirements of fair value hedge accounting, then the entity shall record in its accounting policies one of the following options: financial results when hedging:
- the amount of the adjustment allocated to equity in the hedge is transferred to the profit or loss account in the period in which income or expenses on the instrument are recognized (for example, depreciation, costs of sales, etc.); if it is expected that the entity will subsequently not be able to recover all or part of the loss on the instrument, then only the amount that is not expected to be recovered is credited to the profit and loss account;
- The amount of the hedge adjustment charged to equity is debited from that account and included in the original or other carrying amount of the recognized financial asset or liability.
If a forecast transaction results in the recognition of a financial asset or financial liability in the balance sheet, the gains or losses previously recognized in equity are transferred to profit or loss in the period in which the asset acquired or liability assumed affects profit or loss (interest interest is recognized). interest income or expenses); if it is assumed that the loss (all or part of it) will not be compensated within the next few periods, then the corresponding amount is transferred to the profit and loss account.
Example 4.6 illustrates a cash flow hedge for a forward contract (an obligation to buy or sell a commodity or financial asset at a specified price at a specified time in the future). The price of a forward contract is equal to the difference between the current value of the object of the contract (the “spot” price) and the price established in the contract).
EXAMPLE
On September 30, the company signed an agreement to purchase equipment in the future for the amount of 1,000,000 Swiss francs. The spot rate (the price specified in the contract) on September 30 was 2.5 Swiss francs per 1 euro.
To reduce the risk of a possible change in the exchange rate in the future, the company enters into a forward agreement on the same day to purchase Swiss francs for dollars at a rate of 2.5 Swiss francs per $1.
On December 31, the market exchange rate for the euro is 2.4 Swiss francs.
(recognized as an asset) is:
1000,000: 2.4 = 416,667 euros.
1000,000: 2.5 = 400,000 euros. / 16,667 euros.
On March 30, the equipment was purchased by the company. The exchange rate is 2.3 Swiss francs per 1 euro.
Fair value of a forward contract is (Fig. 3):
1,000,000: 2.3 = 343,783 euros.
1,000,000: 2.5 = 400,000 euros. / 34,783 euros.
Fig.3. Recording hedging transactions using a forward contract as a double entry
All amounts for other hedging transactions written off to equity are recognized in profit or loss if the resulting financial instrument is sold or otherwise affects the financial performance of the entity.
Hedging a net investment in a foreign company is carried out in the same way as a cash flow hedge, i.e. the effective part of the adjustment is written off to capital accounts. The remaining part is transferred to profit and loss accounts, as positive or negative exchange rate differences.
Net investment in foreign activities is expressed by the company's share of net foreign assets.
As stated above, under IAS 39, a transaction can only be accounted for as a hedge if the hedge is effective. There are several mandatory hedge effectiveness tests that must be performed both prospectively and retrospectively.
Prospective testing of effectiveness should be performed at the inception of a hedge transaction and at each subsequent reporting date during the life of the hedge. The test results must demonstrate that the entity's expected changes in fair value or cash flows attributable to the hedged item were substantially fully (ie, substantially 100%) offset by changes in the fair value or cash flows of the hedging instrument.
Retrospective testing of effectiveness is performed at each reporting date during the life of the hedge in accordance with the methodology specified in the documentation of the hedge transaction. Test results should show high effectiveness of the hedging relationship (in the range of 80-125%). In this case, the effectiveness of the hedge is regularly and immediately reflected in the income statement.
Hedge accounting must be discontinued when any of the following events occur:
- the hedging transaction fails the effectiveness test;
- the hedging instrument is sold, terminated or exercised;
- final settlement has been made for the hedged position;
- the hedging relationship is cancelled;
- In a cash flow hedge, the hedged forecast transaction will not occur.
IFRS 39 allows you to simultaneously take into account financial results from changes in the value of the hedged item and changes in the value of the financial instrument used for hedging, while Bank of Russia regulations do not yet provide for consideration of hedging as a single operation, and require separate accounting for changes in the value of the hedged item and a hedging instrument.
Disclosures in IFRS 39
Carrying out transactions with financial instruments is accompanied by corresponding financial risks, therefore, the disclosure of information in the reporting of banks and companies is intended to help its users in correctly assessing the degree of exposure of the bank (company) to financial risks as a result of such transactions.
In the notes to the statements, it is necessary to disclose the methods and assumptions used in assessing the fair value of financial assets and financial liabilities reflected at fair value, separately for their largest classes (formed according to such characteristics as, for example, recognition or non-recognition in the balance sheet, methods for determining fair value, etc.).
It is also necessary to specify how gains and losses resulting from changes in the fair value of available-for-sale financial assets carried at fair value are accounted for after initial recognition: whether they are charged to net profit or loss for the period or directly to equity until sold. financial asset.
Additional disclosures relate to hedging matters, specifically a description of the company's financial risk management policies and objectives, including its hedging policies for each major class of expected transaction.
For example, when hedging risks associated with future sales, the description should indicate the nature of the risks being hedged, the approximate number of months (years) of expected future sales covered by the hedge, and the approximate percentage of the transaction value of sales for the period under review.
For fair value hedges, cash flow hedges, and hedges of a net investment in a foreign company, the following information is separately disclosed:
- description of the hedge;
- a description of the financial instruments designated as hedging instruments and their fair value at the reporting date;
- the nature of the risks being hedged.
When hedging expected transactions, the following are disclosed:
- planned timing of expected transactions;
- the expected timing of inclusion of financial results on them in the calculation of net profit or loss.
If the gain or loss on derivatives and non-derivative financial instruments designated as cash flow hedges is recognized directly in equity (in the statement of changes in equity), the following must be disclosed in the explanatory note:
- periods when transactions are expected to be carried out;
- the timing of the expected impact of transactions on earnings;
- a description of any transaction that was previously accounted for as a hedge but is expected to no longer occur;
- the amount recognized in equity in the current period;
- the amount of profit (loss) written off from capital accounts and included in net profit or loss for the reporting period; The amount written off from equity and included in the cost or other carrying amount of an asset or liability in a hedged expected transaction during the current period.
If a gain (loss) on the remeasurement of the fair value of available-for-sale financial assets (not related to the hedging process) has been recognized directly in equity in the statement of changes in equity, the following disclosures are made:
- the amount recognized in the equity accounts in the current period;
- the amount of profit (loss) written off from capital accounts and included in net profit or loss for the reporting period.
If the fair value of financial assets (investments in unquoted equity instruments) cannot be measured reliably and they are carried at cost, the following should be included:
- an indication of this fact along with a description of the assets;
- their book value; and an explanation of why their fair value cannot be measured reliably;
- where possible, the range of fair value measurements;
- any gain/loss arising on the sale of such assets;
- significant assumptions and methods used to determine fair value (based on market prices or special valuation techniques).
When fair values are determined based on valuation techniques, the following are disclosed:
- assumed fair value level assumptions in the absence of available market prices;
- the sensitivity of the assumptions made in determining the cost (where applicable);
- the change in fair value recognized in profit or loss for the reporting period.
Significant items of income, expenses, gains and losses on financial assets and financial liabilities, whether included in net income or loss or as part of equity, should be disclosed, including:
- total interest income and total interest expense on financial assets (liabilities) not measured at fair value;
- on financial assets available for sale, gains (losses) recognized in equity, as well as amounts transferred from equity to profit during the reporting period;
- interest income accrued on impaired financial assets.
For transferred financial assets that cannot be derecognised (for example, a repurchase agreement), or for cases where the entity continues to be involved in the securitized financial assets, the following is provided:
- a detailed description of the assets, including a description of the collateral;
- the nature of ongoing participation;
- the volume of such transfers/transactions;
- information about remaining risks.
In addition, IFRS 39 provides for other specific disclosures, in particular regarding:
- reasons for reclassifying financial assets from the category recorded at cost (amortized) cost to the category recorded at fair value;
- impairment losses for each significant class of financial assets;
- accepted or used as security for collateral;
- the carrying amounts of financial assets and financial liabilities classified as “held for trading” and measured at fair value through profit or loss;
- financial liabilities recorded at fair value through profit or loss: the amount of changes in fair value that are not attributable to changes in the benchmark interest rate and the difference between the carrying amount and the amount that the entity is required to pay under the terms of the contract;
- the presence of multiple embedded derivatives whose values are interdependent in the combined instrument, together with effective rates for the liability component;
- defaults of principal (interest) on loans and any other violation of loan agreements that allow the lender to demand immediate repayment of the instrument.