Financial Instruments Accounting
Underlying principles
Mixed attribute model
- Amortised cost
- Fair value
Derivatives
Hedge accounting
Impairment of loans
Underlying Principles
Financial instruments & derivatives are assets & liabilities
Fair value is most relevant measure for financial instruments, and is the only relevant measure for derivatives
Deferred losses are not assets
Deferred gains are not liabilities
Special accounting only for qualifying items
Classification of Financial Instruments
Financial assets
- Held for trading (HFT)
- Held to maturity (HTM)
- Loans and receivables
Available for sale (AFS)
Financial liabilities
- Held for trading (HFT)
- Other
Financial Assets
Measure at fair value (changes in P&L)
- Financial assets held for trading
- All derivatives
- Election at inception for all others
Measure at amortised cost
- Held-to-maturity investments
- Loans and receivables
Measure at fair value (changes in equity)
- All others (except some unquoted equities)
Financial Liabilities
Measure at fair value (changes in P&L)
- Financial liabilities held for trading
- All derivatives
- Election at inception for all others (change to old IAS 39)
Amortised cost
- AII others
Definition of Fair Value
• Fair value:
> Is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction
• Best evidence:
> Quoted market price in active market
• No quote:
> Estimation techniques (similar instruments, DCF, option pricing models)
Derivatives Principles
Derivatives should be recognised
- they create assets and liabilities
Derivatives should be measured at fair value
- only relevant measurement attribute
cost is nil
are often highly leveraged
- provides transparency about their use
Derivatives embedded in other assets or liabilities should be separated
Examples of Underlying Risks
Interest rate
Security price (equity, debt)
Commodity price
Foreign exchange rate
Credit rating
Scope exclusions:
- Weather derivatives
- Certain credit default products
- Certain commodity contracts
Embedded Derivatives
Separate an embedded derivative if:
- Economic characteristics and risks not closely related to the host insurance contract
- Separate instrument meets the definition of a derivative
- Combined instrument is not measured at fair value, with changes in fair value reported in P&L
Use fair value, with changes to P&L
Hedge Accounting
Need for hedge accounting
Existing requirements
Types of hedge:
- Fair value hedge
- Cash flow hedge
- Hedge of net investment in foreign operations
Fair Value Hedge
Hedge of the exposure to changes in the fair value of a recognized asset or liability
Example
- Fixed rate debt hedged with a fixed/floating interest rate swap
Fair Value Hedge Accounting
Gain/loss on hedging instrument to net income
Gain/loss on hedged instrument attributable to hedged risk to net income AND adjust carrying amount of hedged item
Cash Flow Hedge
Hedge of exposure to variability in cash flows
Example
- Anticipated transactions in a foreign currency (e.g. anticipated sales or purchases) hedged with an FX forward contract
Cash Flow Hedge Accounting
Effective portion of gain/loss on hedging instrument recognised initially in equity
Subsequently, that amount is included in net income in the same period or periods during which the hedged item affects net income.