Standards Committee (IASC) has published, for public comment, proposed
standards on recognition and measurement of financial instruments. The proposal
is part of a series of projects that IASC has undertaken in the area of
financial instruments. An earlier project led to final standards for disclosure
and presentation that took effect in 1996.
The new accounting proposals are set
out in Exposure Draft E62, Financial Instruments: Recognition and Measurement.
E62 would take effect for financial years beginning on or after 1 January 2001.
"E62 represents a major
milestone in what has proved to be the most challenging project in IASC's
history,"" said Sir Bryan Carsberg, Secretary-General of the IASC.
"Because of wide ranging concerns, we were never able to finalise two
prior Exposure Drafts, E40 and E48, issued in 1991 and 1994 respectively. And a
March 1997 Discussion Paper that proposed measuring all financial assets and
liabilities at fair value, with fair value adjustments reported in income, met
with a number of concerns. Our constituents expressed particular discomfort
about the usefulness and reliability of comprehensive fair value measurements,
especially for an enterprise's own debt. They also raised issues about the
understandability of the resulting effects on income. A number of
industry-specific concerns were also expressed, such as how a bank might
measure the fair value of its 'core deposits'. We concluded that further and
comprehensive study of those matters was essential."
That kind of study might take several
years, and delaying a recognition and measurement proposal for financial
instruments simply is not an option for IASC. "There is an urgent need for
the standard," said Paul Pacter, the IASC's project manager on E62.
"In many of our 101 member countries, the variety of current reporting
practices creates a risk that investors who rely on accounting reports labelled
as complying with IASC standards may not be adequately forewarned of damaging
investment losses or may not understand how corporate profits can be altered by
selective securities sales. On top of that, there is urgency about IASC
completing its 'core standards' to allow the International Organization of
Securities Commissions to consider its endorsement of our work as soon as
possible. I believe that E62 represents a big step forward in accounting for
financial instruments while still allowing us to explore the concerns that were
expressed about a full fair value model."
The Standards proposed in E62 would
be required only for publicly-traded companies. Other companies would be
encouraged to follow them as well.
IASC is proposing that all financial
assets and financial liabilities must be recognised on the balance sheet,
including all derivatives. They would initially be measured at cost, which is
the fair value of whatever was paid or received to acquire the financial asset
At present, many companies do not
recognise some types of derivatives at acquisition because they have a zero
cost, and they continue to keep them out of their accounting reports even if
their value changes to a significant positive or negative amount. Additionally,
many companies measure financial assets at amortised cost even though there are
reliable quoted market prices, those prices differ widely from amortised cost,
and the assets are readily available for sale.
Under E62, subsequent to initial
recognition, all financial assets would be remeasured to fair value, except for
the following, which would be carried at amortised cost:
- fixed maturity investments, such as
debt, loans, receivables, and mandatorily redeemable preferred shares, that
enterprise intends and is able to hold to maturity; and
- financial assets whose fair value
cannot be reliably measured.
On the other hand, after acquisition
under E62 most financial liabilities will be measured at original recorded
amount less principal repayments and amortisations. Only derivatives and
trading liabilities are remeasured to fair value.
For those financial assets and
liabilities that are remeasured to fair value, an enterprise would have a
single, company-wide option either to:
- recognise the entire adjustment in
net profit or loss for the period, or
- recognise in net profit or loss for
the period only the portion of the adjustment relating to securities held for
short-term trading, with the non-trading portion reported in equity until the
financial asset is sold, at which time the realised gain or loss is reported in
net profit or loss.
E62 proposes conditions for
determining when control over a financial asset or liability has been
transferred to another party. If part of a financial asset or liability is sold
or extinguished, the carrying amount is split based on relative fair values. If
fair values are not determinable, a cost recovery approach to profit
recognition is taken.
Hedging, for accounting purposes,
means designating a derivative or other financial instrument as an offset, in
whole or in part, to the change in fair value or cash flows of a hedged item. A
hedged item can be an asset, liability, firm commitment, or forecasted future
transaction that is exposed to risk of change in value or changes in future
cash flows. Hedge accounting recognises the offsetting effects on net profit or
Hedge accounting would be permitted
under E62 in certain circumstances, provided that the hedging relationship is
clearly defined, measurable, and actually effective. E62 provides guidance on
when a hedge is effective.
To encourage commentators, IASC has
put the complete text of E62 on its Internet web site for people to access
electronically for the first time. The web site address is
http://www.iasc.org.uk Printed copies of E62 are also available from IASC's
Publications Department, 7th Floor, 166 Fleet Street, London EC4A 2DY, United
Kingdom, Tel: +44 (171) 427-5927, Fax: +44 (0171) 353-0562 at a price of
£15 each (US $25).
IASC has requested that comments be
sent by E-mail to: CommentLetters@iasc.org.uk so as to be received by 30
September 1998 (though it will endeavour to consider late comments up to 25
October). The Board's goal is to approve a final Standard by the end of 1998.
That Standard will not complete
IASC's work in the area of financial instruments. Work continues through IASC's
participation, with representatives of 12 national standard-setters, in a task
force that is developing a proposal that will deal more comprehensively with
fair value adjustments for all financial assets and financial liabilities and
with reporting those adjustments in income.
Additional Information for Editors
Regarding Hedge Accounting
For a hedge of changes in the fair
value of an existing asset or liability, any gain or loss on the hedging
instrument and on the hedged item are included in net profit or loss for the
period. The carrying amount of the hedged item is adjusted even if that asset
or liability is otherwise carried at cost.
For a cash flow hedge of an existing
asset or liability or a forecasted transaction, the gain or loss on the hedging
instrument is reported directly in equity until the hedged transaction affects
net profit or loss. A key question for hedges of anticipated asset acquisitions
is whether the amount reported in equity becomes part of the measure of the
original acquisition cost of the asset when the forecasted transaction occurs.
E62 invites comment on two alternatives but does not express preference for
- leave the amount in equity and
amortise it over the same periods as the acquired asset or liability affects
profit or loss, or
- transfer the amount as part of cost
of the acquired asset or liability. This is sometimes called "basis