IAS 39 (1998)
Financial Instruments: Recognition and Measurement
(effective 1 January 2001)
Table of Contents
IAS 39 establishes standards for recognizing, measuring, and disclosing information about an enterprise's financial assets and financial liabilities, including accounting for hedging transactions. IAS 39, together with IAS 32, which deals with presentation and disclosure of financial instruments, are IASC's two main pronouncements on the subject, though several other existing Standards also address matters relating to financial instruments.
IAS 39 will bring about a substantial improvement in accounting for financial instruments. At the same time, the Board recognizes the need for further development. IASC is participating in an international Joint Working Group that is exploring the feasibility of fair valuing all financial assets and financial liabilities, working from the proposals in a March 1997 IASC Discussion Paper, Accounting for Financial Assets and Financial Liabilities.
The introduction to IAS 39 reviews the background of IASC's work on financial instruments.
IAS 39 is operative for financial statements covering financial years beginning on or after 1 January 2001. Earlier application is permitted as of the beginning of a financial year that ends after 15 March 1999, the date of issuance of IAS 39.
1. This Standard ('IAS 39') establishes principles for recognizing, measuring, and
disclosing information about financial assets and financial liabilities. It is IASC's
first comprehensive Standard on the subject, though some issues within the scope of this
Standard have been addressed in other Standards. IAS 25, Accounting for Investments,
covered recognition and measurement of debt and equity investments, as well as investments
in land and buildings and other tangible and intangible assets held as investments. This
Standard supersedes IAS 25 except with respect to land and buildings and other tangible
and intangible assets held as investments. IASC is currently developing a Standard on such
investment properties. IAS 38, Intangible Assets, superseded IAS 25 with respect to
investments in intangible assets. This Standard also supplements the disclosure provisions
of IAS 32, Financial Instruments: Disclosure and Presentation. The various amendments to
existing International Accounting Standards are set out at the end of this Standard. IAS
39 is effective for financial statements for financial years beginning on or after 1
January 2001. Earlier application is permitted only as of the beginning of a financial
year that ends after 15 March 1999, the date of issuance of this Standard.
2. In 1988, IASC began a project, jointly with the Canadian Institute of Chartered Accountants, to develop a comprehensive Standard on the recognition, measurement, and disclosure of financial instruments. IASC issued an exposure draft (E40) for comment in September 1991. Based on extensive input received, the proposals were reconsidered and a re-exposure draft (E48) was issued for comment in January 1994.
3. In view of the critical responses to E48, evolving practices in the use of financial instruments, and developing thinking by certain national accounting standard setters, IASC decided to divide the project into phases, starting with disclosure and financial statement presentation.
4. The first phase was completed in March 1995 when the IASC Board approved IAS 32,
Financial Instruments: Disclosure and Presentation. IAS 32 deals with:
(a) classification by issuers of financial instruments as liabilities or equity, and the
classification of related interest, dividends, and gains and losses. This includes the
separation of certain compound instruments into their liability and equity
components;
(b) offsetting of financial assets and financial liabilities; and
(c) disclosure of information about financial instruments.
5. The second phase of the project is to consider further the issues of recognition, discontinuing recognition ('derecognition'), measurement, and hedge accounting. This Standard addresses those matters.
6. In July 1995, IASC reached agreement with the International Organization of Securities Commissions (IOSCO) on the content of a work programme to complete a core set of International Accounting Standards that could be endorsed by IOSCO for cross-border capital raising and listing purposes in all global markets. Those core standards include standards on recognition and measurement of financial instruments, off-balance sheet items, hedging, and investments. The disclosure standards of IAS 32, by themselves, do not fulfill IASC's commitment to IOSCO with respect to the minimum core standards.
7. In March 1997, IASC, jointly with the Canadian Institute of Chartered Accountants, published a comprehensive Discussion Paper, Accounting for Financial Assets and Financial Liabilities, and invited comments on the proposals therein. IASC held a series of special consultative meetings about those proposals with various national and international interest groups and in numerous countries. Those meetings and analysis of comment letters on the Discussion Paper confirm that IASC faces controversies and complexities in seeking a way forward. While some acceptance exists of the view put forward in the Discussion Paper - that measurement of all financial assets and liabilities at fair value is necessary to obtain consistency and relevance to users - application of that concept to some industries and to some kinds of financial assets and liabilities continues to present difficulty. Widespread unease is also evident about the prospect of including unrealized gains, particularly on long-term debt, in income as proposed in the Discussion Paper. Those difficulties will not be easily or quickly resolved. Further, while several national standard setters have undertaken projects to develop national standards on various aspects of recognition and measurement of financial instruments, no country has in place or proposed standards that are similar to the proposals in the Discussion Paper.
8. Completion of a single comprehensive International Accounting Standard on financial instruments based on the Discussion Paper for inclusion, before the end of 1998, in the core standards to be considered by IOSCO was not a realistic possibility. Nonetheless, the ability to use International Accounting Standards for investment and credit decisions and securities offerings and listings is urgent for both investors and business enterprises. Moreover, while financial instruments are widely held and used throughout the world, only a very few countries now have any national recognition and measurement standards at all for financial instruments.
9. At its meeting in November 1997, therefore, the IASC Board decided that:
(a) IASC should join with national standard setters to develop an integrated and
harmonized international accounting standard on financial instruments. That standard would
build on the IASC Discussion Paper, existing and emerging national standards, and the best
thinking and research on the subject world wide; and
(b) at the same time, recognizing the urgency of the matter, IASC should work to complete
an interim international Standard on recognition and measurement of financial instruments
in 1998. That solution, along with IAS 32 on disclosure and presentation of financial
instruments and several other existing International Accounting Standards that address
matters relating to financial instruments, will serve until the integrated comprehensive
standard is completed.
10. A Joint Working Group comprising representatives of IASC and a number of national standard setters has begun work on the first of the foregoing two steps. This Standard is intended to accomplish the second step. IASC recognizes that the proposals in its March 1997 Discussion Paper represent far-reaching changes from traditional accounting practices for financial instruments and that a number of difficult technical issues (which were discussed in the Discussion Paper) need to be resolved before standards fully reflecting those proposals could be put in place. IASC also believes that a programme of development work, field testing, preparation of guidance material, and education will be necessary to enable those principles to be effectively implemented. The IASC Board is committed to work with national standard setters throughout the world to achieve those goals within a reasonable time. In the interim, until those goals are achieved, this Standard will significantly improve the reporting of financial instruments.
11. This Standard is based on Exposure Draft E62, which IASC issued for public comment on 17 June 1998. The formal comment deadline was 30 September 1998, but the Board announced that it would make every effort to consider comments received by 25 October, which it did. Constituents' views about the proposals in E62 were also solicited by a series of more than 20 seminars conducted around the world by the project manager and through published summaries of E62 in professional journals. To ensure the longest possible period for IASC constituents to review and develop their comments on E62, a copy of E62 was posted on IASC's web site for downloading
12. Issues arising as a result of the comment process were considered by an IASC
Steering Committee, which made recommendations to the Board, and then by the Board itself
at meetings in November and December 1998.
Greater Use of Fair Values for Financial Instruments
13. This Standard significantly increases the use of fair values in accounting for
financial instruments, consistent with the direction the Board has given to the Joint
Working Group to continue to study further the use of full fair value accounting for all
financial assets and liabilities. This Standard changes current practice by requiring the
use of fair values for:
(a) nearly all derivative assets and derivative liabilities (today these are often not
even recognized, let alone measured at fair value);
(b) all debt securities, equity securities, and other financial assets held for trading
(IAS 25 allows these to be reported at cost, lower of cost and market, or fair value, and
practice today is mixed);
(c) all debt securities, equity securities, and other financial assets that are not held
for trading but nonetheless are available for sale (IAS 25 allows these to be reported at
cost, lower of cost and market, or fair value, and today they are generally reported at
cost);
(d) certain derivatives that are embedded in non-derivative instruments (generally not
recognized today);
(e) non-derivative financial instruments containing embedded derivative instruments that
cannot be reliably separated from the non-derivative instrument (generally measured at
amortized cost today);
(f) non-derivative assets and liabilities that have fair value exposures being hedged by
derivative instruments (since there are no hedge accounting standards today, practice
varies widely);
(g) fixed maturity investments that the enterprise does not designate as 'held to
maturity' (IAS 25 allows these to be reported at cost, lower of cost and market, or fair
value, and today they are generally reported at cost); and
(h) purchased loans and receivables that the enterprise does not designate as 'held to
maturity' (IAS 25 allows these to be reported at cost, lower of cost and market, or fair
value, and today they are generally reported at cost).
14. The three classes of financial assets that remain carried at cost under this Standard are loans and receivables originated by the enterprise, other fixed-maturity investments that the enterprise intends and is able to hold to maturity, and unquoted equity instruments whose fair value cannot be reliably measured (including derivatives that are linked to and must be settled by delivery of such unquoted equity instruments). The Board decided not to require fair value measurement for the loans, receivables, and other fixed maturity investments at this time for a number of reasons. One is the significance of the change from current practice that would be required in many jurisdictions. Another reason is the portfolio linkage of loans, receivables, and other fixed maturity investments, in many industries, to liabilities that, under this Standard, will be measured at their amortized original amount. Also, some question the relevance of fair values for fixed maturity investments intended to be held until maturity. The Joint Working Group is studying those matters.
15. Whether and how fair value can be reliably estimated for the unquoted equity instruments is also under study by the Joint Working Group. Most liabilities are not measured at fair value under this Standard - though all derivative liabilities (unless indexed to an unquoted equity instrument whose fair value cannot be reliably measured) and those held for trading are measured at fair value. Fair valuation of liabilities is the subject of several studies currently being undertaken by the Joint Working Group.
Summary of this Standard
16. Under this Standard, all financial assets and financial liabilities should be recognized on the balance sheet, including all derivatives. They should initially be measured at cost, which is the fair value of the consideration given or received to acquire the financial asset or liability (plus certain hedging gains and losses).
17. Subsequent to initial recognition, all financial assets should be remeasured to
fair value, except for the following, which should be carried at amortized cost subject to
a test for impairment:
(a) loans and receivables originated by the enterprise and not held for trading;
(b) other fixed maturity investments, such as debt securities and mandatorily redeemable
preferred shares, that the enterprise intends and is able to hold to maturity; and
(c) financial assets whose fair value cannot be reliably measured (limited to some equity
instruments with no quoted market price and some derivatives that are linked to and must
be settled by delivery of such unquoted equity instruments).
18. After acquisition most financial liabilities should be measured at original recorded amount less principal repayments and amortization. Only derivatives and liabilities held for trading should be remeasured to fair value.
19. For those financial assets and liabilities that are remeasured to fair value, an
enterprise will have a single, enterprise-wide option to either:
(a) recognize the entire adjustment in net profit or loss for the period; or
(b) recognize in net profit or loss for the period only those changes in fair value
relating to financial assets and liabilities held for trading, with the value changes for
non-trading instruments reported in equity until the financial asset is sold, at which
time the realized gain or loss is reported in net profit or loss. For this purpose,
derivatives are always deemed held for trading unless they are part of a hedging
relationship that qualifies for hedge accounting.
20. This Standard establishes conditions for determining when control over a financial asset or liability has been transferred to another party. For financial assets a transfer normally would be recognized if (a) the transferee has the right to sell or pledge the asset and (b) the transferor does not have the right to reacquire the transferred assets unless either the asset is readily obtainable in the market or the reacquisition price is fair value at the time of reacquisition. With respect to derecognition of liabilities, the debtor must be legally released from primary responsibility for the liability (or part thereof) either judicially or by the creditor. 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.
21. Hedging, for accounting purposes, means designating a derivative or (in limited circumstances) a non-derivative 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 recognizes the offsetting effects on net profit or loss symmetrically.
22. Hedge accounting is permitted under this Standard in certain circumstances, provided that the hedging relationship is clearly defined, measurable, and actually effective.
23. This Standard applies to insurance enterprises except for rights and obligations under insurance contracts. This Standard applies to derivatives that are embedded in insurance contracts. A separate IASC project is under way on accounting for insurance contracts.
International Accounting Standard IAS 39
Financial Instruments: Recognition and Measurement
The standards, which have been set in bold italic type, should be read in the context of the background material and implementation guidance in this Standard, and in the context of the Preface to International Accounting Standards. International Accounting Standards are not intended to apply to immaterial items (see paragraph 12 of the Preface).
The objective of this Standard is to establish principles for recognizing, measuring, and disclosing information about financial instruments in the financial statements of business enterprises.
1. This Standard should be applied by all enterprises to all financial
instruments except:
(a) those interests in subsidiaries, associates, and joint ventures that are accounted for
under IAS 27, Consolidated Financial Statements and Accounting for Investments in
Subsidiaries; IAS 28, Accounting for Investments in Associates; and IAS 31, Financial
Reporting of Interests in Joint Ventures;
(b) rights and obligations under leases, to which IAS 17, Leases, applies; however, (i)
lease receivables recognized on a lessor's balance sheet are subject to the derecognition
provisions of this Standard (paragraphs 35-65 and 170(d)) and (ii) this Standard does
apply to derivatives that are embedded in leases (see paragraphs 22-26);
(c) employers' assets and liabilities under employee benefit plans, to which IAS 19,
Employee Benefits, applies;
(d) rights and obligations under insurance contracts as defined in paragraph 3 of IAS 32,
Financial Instruments: Disclosure and Presentation, but this Standard does apply to
derivatives that are embedded in insurance contracts (see paragraphs 22-26);
(e) equity instruments issued by the reporting enterprise including options, warrants, and
other financial instruments that are classified as shareholders' equity of the reporting
enterprise (however, the holder of such instruments is required to apply this Standard to
those instruments);
(f) financial guarantee contracts, including letters of credit, that provide for payments
to be made if the debtor fails to make payment when due (IAS 37, Provisions, Contingent
Liabilities and Contingent Assets, provides guidance for recognizing and measuring
financial guarantees, warranty obligations, and other similar instruments). In contrast,
financial guarantee contracts are subject to this Standard if they provide for payments to
be made in response to changes in a specified interest rate, security price, commodity
price, credit rating, foreign exchange rate, index of prices or rates, or other variable
(sometimes called the 'underlying'). Also, this Standard does require recognition of
financial guarantees incurred or retained as a result of the derecognition standards set
out in paragraphs 35-65;
(g) contracts for contingent consideration in a business combination (see paragraphs 65-76
of IAS 22 (Revised 1998), Business Combinations);
(h) contracts that require a payment based on climatic, geological, or other physical
variables (see paragraph 2), but this Standard does apply to other types of derivatives
that are embedded in such contracts (see paragraphs 22-26).
2. Contracts that require a payment based on climatic, geological, or other physical variables are commonly used as insurance policies. (Those based on climatic variables are sometimes referred to as weather derivatives.) In such cases, the payment made is based on an amount of loss to the enterprise. Rights and obligations under insurance contracts are excluded from the scope of this Standard by paragraph 1(d). The Board recognizes that the payout under some of these contracts is unrelated to the amount of an enterprise's loss. While the Board considered leaving such derivatives within the scope of the Standard, it concluded that further study is needed to develop operational definitions that distinguish between 'insurance-type' and 'derivative type' contracts.
3. This Standard does not change the requirements relating to:
(a) accounting by a parent for investments in subsidiaries in the parent's separate
financial statements as set out in paragraphs 29-31 of IAS 27;
(b) accounting by an investor for investments in associates in the investor's separate
financial statements as set out in paragraphs 12-15 of IAS 28;
(c) accounting by a joint venturer for investments in joint ventures in the venturer's or
investor's separate financial statements as set out in paragraphs 35 and 42 of IAS 31; or
(d) employee benefit plans that comply with IAS 26, Accounting and Reporting by Retirement
Benefit Plans.
4. Sometimes, an enterprise makes what it views as a 'strategic investment' in equity securities issued by another enterprise, with the intent of establishing or maintaining a long-term operating relationship with the enterprise in which the investment is made. The investor enterprise uses IAS 28, Accounting for Investments in Associates, to determine whether the equity method of accounting is appropriate for such an investment because the investor has significant influence over the associate. Similarly, the investor enterprise uses IAS 31, Financial Reporting of Interests in Joint Ventures, to determine whether proportionate consolidation or the equity method is appropriate for such an investment. If neither the equity method nor proportionate consolidation is appropriate, the enterprise will apply this Standard to that strategic investment.
5. This Standard applies to the financial assets and liabilities of insurance companies other than rights and obligations arising under insurance contracts, which are excluded by paragraph 1(d). A separate IASC project on accounting for insurance contracts is currently under way, and it will address rights and obligations arising under insurance contracts. See paragraphs 22-26 for guidance on financial instruments that are embedded in insurance contracts.
6. This Standard should be applied to commodity-based contracts that give either party the right to settle in cash or some other financial instrument, with the exception of commodity contracts that (a) were entered into and continue to meet the enterprise's expected purchase, sale, or usage requirements, (b) were designated for that purpose at their inception, and (c) are expected to be settled by delivery.
7. If an enterprise follows a pattern of entering into offsetting contracts that effectively accomplish settlement on a net basis, those contracts are not entered into to meet the enterprise's expected purchase, sale, or usage requirements.
From IAS 32
8. The following terms are used in this Standard with the meanings specified in
IAS 32:
A financial instrument is any contract that gives rise to both a financial asset of one
enterprise and a financial liability or equity instrument of another enterprise.
A financial asset is any asset that is:
(a) cash;
(b) a contractual right to receive cash or another financial asset from another
enterprise;
(c) a contractual right to exchange financial instruments with another enterprise under
conditions that are potentially favorable; or
(d) an equity instrument of another enterprise.
A financial liability is any liability that is a contractual obligation:
(a) to deliver cash or another financial asset to another enterprise; or
(b) to exchange financial instruments with another enterprise under conditions that are
potentially unfavorable.
An equity instrument is any contract that evidences a residual interest in the assets of
an enterprise after deducting all of its liabilities (see paragraph 11).
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.
9. For purposes of the foregoing definitions, IAS 32 states that the term 'enterprise' includes individuals, partnerships, incorporated bodies, and government agencies.
10. The following terms are used in this Standard with the meanings specified:
Definition of a Derivative
A derivative is a financial instrument:
(a) whose value changes in response to the change in a specified interest rate,
security price, commodity price, foreign exchange rate, index of prices or rates, a credit
rating or credit index, or similar variable (sometimes called the 'underlying');
(b) that requires no initial net investment or little initial net investment relative to
other types of contracts that have a similar response to changes in market conditions; and
(c) that is settled at a future date.
Definitions of Four Categories of Financial Assets
A financial asset or liability held for trading is one that was acquired
or incurred principally for the purpose of generating a profit from short-term
fluctuations in price or dealer's margin. A financial asset should be classified as held
for trading if, regardless of why it was acquired, it is part of a portfolio for which
there is evidence of a recent actual pattern of short-term profit-taking (see paragraph
21). Derivative financial assets and derivative financial liabilities are always deemed
held for trading unless they are designated and effective hedging instruments. (See
paragraph 18 for an example of a liability held for trading.)
Held-to-maturity investments are financial assets with fixed or determinable
payments and fixed maturity that an enterprise has the positive intent and ability to hold
to maturity (see paragraphs 80-92) other than loans and receivables originated by the
enterprise.
Loans and receivables originated by the enterprise are financial assets that are
created by the enterprise by providing money, goods, or services directly to a debtor,
other than those that are originated with the intent to be sold immediately or in the
short term, which should be classified as held for trading. Loans and receivables
originated by the enterprise are not included in held-to-maturity investments but, rather,
are classified separately under this Standard (see paragraphs 19-20).
Available-for-sale financial assets are those financial assets that are not (a)
loans and receivables originated by the enterprise, (b) held-to-maturity investments, or
(c) financial assets held for trading (see paragraph 21).
Definitions Relating to Recognition and Measurement
Amortized cost of a financial asset or financial liability is the amount
at which the financial asset or liability was measured at initial recognition minus
principal repayments, plus or minus the cumulative amortization of any difference between
that initial amount and the maturity amount, and minus any write-down (directly or through
the use of an allowance account) for impairment or uncollectability.
The effective interest method is a method of calculating amortization using the
effective interest rate of a financial asset or financial liability. The effective
interest rate is the rate that exactly discounts the expected stream of future cash
payments through maturity or the next market-based repricing date to the current net
carrying amount of the financial asset or financial liability. That computation should
include all fees and points paid or received between parties to the contract. The
effective interest rate is sometimes termed the level yield to maturity or to the next
repricing date, and is the internal rate of return of the financial asset or financial
liability for that period. (See IAS 18, Revenue, paragraph 31, and IAS 32, paragraph 61.)
Transaction costs are incremental costs that are directly attributable to the
acquisition or disposal of a financial asset or liability (see paragraph 17).
A firm commitment is a binding agreement for the exchange of a specified quantity of
resources at a specified price on a specified future date or dates.
Control of an asset is the power to obtain the future economic benefits that flow
from the asset.
Derecognize means remove a financial asset or liability, or a portion of a
financial asset or liability, from an enterprise's balance sheet.
Definitions Relating to Hedge Accounting
Hedging, for accounting purposes, means designating one or more hedging
instruments so that their change in fair value is an offset, in whole or in part, to the
change in fair value or cash flows of a hedged item.
A hedged item is an asset, liability, firm commitment, or forecasted future
transaction that (a) exposes the enterprise to risk of changes in fair value or changes in
future cash flows and that (b) for hedge accounting purposes, is designated as being
hedged (paragraphs 127-135 elaborate on the definition of hedged items).
A hedging instrument, for hedge accounting purposes, is a designated derivative or
(in limited circumstances) another financial asset or liability whose fair value or cash
flows are expected to offset changes in the fair value or cash flows of a designated
hedged item (paragraphs 122-126 elaborate on the definition of a hedging instrument).
Under this Standard, a non-derivative financial asset or liability may be designated as a
hedging instrument for hedge accounting purposes only if it hedges the risk of changes in
foreign currency exchange rates.
Hedge effectiveness is the degree to which offsetting changes in fair value or cash
flows attributable to a hedged risk are achieved by the hedging instrument (see paragraphs
146-152).
Other Definitions
Securitization is the process by which financial assets are transformed
into securities.
A repurchase agreement is an agreement to transfer a financial asset to another
party in exchange for cash or other consideration and a concurrent obligation to reacquire
the financial asset at a future date for an amount equal to the cash or other
consideration exchanged plus interest.
Elaboration on the Definitions
11. An enterprise may have a contractual obligation that it can settle either by payment of financial assets or by payment in the form of its own equity securities. In such a case, if the number of equity securities required to settle the obligation varies with changes in their fair value so that the total fair value of the equity securities paid always equals the amount of the contractual obligation, the holder of the obligation is not exposed to gain or loss from fluctuations in the price of the equity securities. Such an obligation should be accounted for as a financial liability of the enterprise and, therefore, is not excluded from the scope of this Standard by paragraph 1(e).
12. An enterprise may have a forward, option, or other derivative instrument whose value changes in response to something other than the market price of the enterprise's own equity securities but that the enterprise can choose to settle or is required to settle in its own equity securities. In such case, the enterprise accounts for the instrument as a derivative instrument, not as an equity instrument, because the value of such an instrument is unrelated to the changes in the equity of the enterprise.
13. Typical examples of derivatives are futures and forward, swap, and option contracts. A derivative usually has a notional amount, which is an amount of currency, a number of shares, a number of units of weight or volume, or other units specified in the contract. However, a derivative instrument does not require the holder or writer to invest or receive the notional amount at the inception of the contract. Alternatively, a derivative could require a fixed payment as a result of some future event that is unrelated to a notional amount. For example, a contract may require a fixed payment of 1,000 if six-month LIBOR increases by 100 basis points. In this example, a notional amount is not specified.
14. Commitments to buy or sell non-financial assets and liabilities that are intended to be settled by the reporting enterprise by making or taking delivery in the normal course of business, and for which there is no practice of settling net (either with the counterparty or by entering into offsetting contracts), are not accounted for as derivatives but rather as executory contracts. Settling net means making a cash payment based on the change in fair value.
15. One of the defining conditions of a derivative is that it requires little initial net investment relative to other contracts that have a similar response to market conditions. An option contract meets that definition because the premium is significantly less than the investment that would be required to obtain the underlying financial instrument to which the option is linked.
16. If an enterprise contracts to buy a financial asset on terms that require delivery of the asset within the time frame established generally by regulation or convention in the market place concerned (sometimes called a 'regular way' contract), the fixed price commitment between trade date and settlement date is a forward contract that meets the definition of a derivative. This Standard provides for special accounting for such regular way contracts (see paragraphs 30-34).
17. Transaction costs include fees and commissions paid to agents, advisers, brokers, and dealers; levies by regulatory agencies and securities exchanges; and transfer taxes and duties. Transaction costs do not include debt premium or discount, financing costs, or allocations of internal administrative or holding costs.
Liability Held for Trading
18. Liabilities held for trading include (a) derivative liabilities that are not hedging instruments and (b) the obligation to deliver securities borrowed by a short seller (an enterprise that sells securities that it does not yet own). The fact that a liability is used to fund trading activities does not make that liability one held for trading.
Loans and Receivables Originated by the Enterprise
19. A loan acquired by an enterprise as a participation in a loan from another lender is considered to be originated by the enterprise provided it is funded by the enterprise on the date that the loan is originated by the other lender. However, the acquisition of an interest in a pool of loans or receivables, for example in connection with a securitization, is a purchase, not an origination, because the enterprise did not provide money, goods, or services directly to the underlying debtors nor acquire its interest through a participation with another lender on the date the underlying loans or receivables were originated. Also, a transaction that is, in substance, a purchase of a loan that was previously originated - for example, a loan to an unconsolidated special purpose entity that is made to provide funding for its purchases of loans originated by others - is not a loan originated by the enterprise. A loan acquired by an enterprise in a business combination is considered to be originated by the acquiring enterprise provided that it was similarly classified by the acquired enterprise. The loan is measured at acquisition under IAS 22, Business Combinations. A loan acquired through a syndication is an originated loan because each lender shares in the origination of the loan and provides money directly to the debtor.
20. Loans or receivables that are purchased by an enterprise, rather than originated, are classified as held to maturity, available for sale, or held for trading, as appropriate.
Available-for-Sale Financial Assets
21. A financial asset is classified as available for sale if it does not properly belong in one of the three other categories of financial assets - held for trading, held to maturity, and loans and receivables originated by the enterprise. A financial asset is classified as held for trading, rather than available for sale, if it is part of a portfolio of similar assets for which there is a pattern of trading for the purpose of generating a profit from short-term fluctuations in price or dealer's margin.
22. Sometimes, a derivative may be a component of a hybrid (combined) financial instrument that includes both the derivative and a host contract - with the effect that some of the cash flows of the combined instrument vary in a similar way to a stand-alone derivative. Such derivatives are sometimes known as 'embedded derivatives'. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified based on a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or other variable.
23. An embedded derivative should be separated from the host contract and
accounted for as a derivative under this Standard if all of the following conditions are
met:
(a) the economic characteristics and risks of the embedded derivative are not closely
related to the economic characteristics and risks of the host contract;
(b) a separate instrument with the same terms as the embedded derivative would meet the
definition of a derivative; and
(c) the hybrid (combined) instrument is not measured at fair value with changes in fair
value reported in net profit or loss.
If an embedded derivative is separated, the host contract itself should be accounted for
(a) under this Standard if it is, itself, a financial instrument and (b) in accordance
with other appropriate International Accounting Standards if it is not a financial
instrument.
24. The economic characteristics and risks of an embedded derivative are not considered
to be closely related to the host contract (paragraph 23(a)) in the following examples. In
these circumstances, assuming the conditions in paragraphs 23(b) and 23(c) are also met,
an enterprise accounts for the embedded derivative separately from the host contract under
this Standard:
(a) a put option on an equity instrument held by an enterprise is not closely related to
the host equity instrument;
(b) a call option embedded in an equity instrument held by an enterprise is not closely
related to the host equity instrument from the perspective of the holder (from the
issuer's perspective, the call option is an equity instrument of the issuer if the issuer
is required to or has the right to require settlement in shares, in which case it is
excluded from the scope of this Standard);
(c) an option or automatic provision to extend the term (maturity date) of debt is not
closely related to the host debt contract held by an enterprise unless there is a
concurrent adjustment to the market rate of interest at the time of the extension;
(d) equity-indexed interest or principal payments - by which the amount of interest or
principal is indexed to the value of equity shares - are not closely related to the host
debt instrument or insurance contract because the risks inherent in the host and the
embedded derivative are dissimilar;
(e) commodity-indexed interest or principal payments - by which the amount of interest or
principal is indexed to the price of a commodity - are not closely related to the host
debt instrument or insurance contract because the risks inherent in the host and the
embedded derivative are dissimilar;
(f) an equity conversion feature embedded in a debt instrument is not closely related to
the host debt instrument;
(g) a call or put option on debt that is issued at a significant discount or premium is
not closely related to the debt except for debt (such as a zero coupon bond) that is
callable or puttable at its accreted amount; and
(h) arrangements known as credit derivatives that are embedded in a host debt instrument
and that allow one party (the 'beneficiary') to transfer the credit risk of an asset,
which it may or may not actually own, to another party (the 'guarantor') are not closely
related to the host debt instrument. Such credit derivatives allow the guarantor to assume
the credit risk associated with a reference asset without directly purchasing it.
25. On the other hand, the economic characteristics and risks of an embedded derivative
are considered to be closely related to the economic characteristics and risks of the host
contract in the following examples. In these circumstances, an enterprise does not account
for the embedded derivative separately from the host contract under this Standard:
(a) the embedded derivative is linked to an interest rate or interest rate index that can
change the amount of interest that would otherwise be paid or received on the host debt
contract (that is, this Standard does not permit floating rate debt to be treated as fixed
rate debt with an embedded derivative);
(b) an embedded floor or cap on interest rates is considered to be closely related to the
interest rate on a debt instrument if the cap is at or above the market rate of interest
or if the floor is at or below the market rate of interest when the instrument is issued,
and the cap or floor is not leveraged in relation to the host instrument;
(c) the embedded derivative is a stream of principal or interest payments that are
denominated in a foreign currency. Such a derivative is not separated from the host
contract because IAS 21, The Effects of Changes in Foreign Exchange Rates, requires that
foreign currency translation gains and losses on the entire host monetary item be
recognized in net profit or loss;
(d) the host contract is not a financial instrument and it requires payments denominated
in (i) the currency of the primary economic environment in which any substantial party to
that contract operates or (ii) the currency in which the price of the related good or
service that is acquired or delivered is routinely denominated in international commerce
(for example, the U.S. dollar for crude oil transactions). That is, such contract is not
regarded as a host contract with an embedded foreign currency derivative;
(e) the embedded derivative is a prepayment option with an exercise price that would not
result in a significant gain or loss;
(f) the embedded derivative is a prepayment option that is embedded in an interest-only or
principal-only strip that (i) initially resulted from separating the right to receive
contractual cash flows of a financial instrument that, in and of itself, did not contain
an embedded derivative and that (ii) does not contain any terms not present in the
original host debt contract;
(g) with regard to a host contract that is a lease, the embedded derivative is (i) an
inflation-related index such as an index of lease payments to a consumer price index
(provided that the lease is not leveraged and the index relates to inflation in the
enterprise's own economic environment), (ii) contingent rentals based on related sales,
and (iii) contingent rentals based on variable interest rates; or
(h) the embedded derivative is an interest rate or interest rate index that does not alter
the net interest payments that otherwise would be paid on the host contract in such a way
that the holder would not recover substantially all of its recorded investment or (in the
case of a derivative that is a liability) the issuer would pay a rate more than twice the
market rate at inception.
26. If an enterprise is required by this Standard to separate an embedded derivative from its host contract but is unable to separately measure the embedded derivative either at acquisition or at a subsequent financial reporting date, it should treat the entire combined contract as a financial instrument held for trading.
27. An enterprise should recognize a financial asset or financial liability on its balance sheet when, and only when, it becomes a party to the contractual provisions of the instrument. (See paragraph 30 with respect to 'regular way' purchases of financial assets.)
28. As a consequence of the principle in the preceding paragraph, an enterprise recognizes all of its contractual rights or obligations under derivatives in its balance sheet as assets or liabilities.
29. The following are some examples of applying the principle in paragraph 27:
(a) unconditional receivables and payables are recognized as assets or liabilities when
the enterprise becomes a party to the contract and, as a consequence, has a legal right to
receive, or a legal obligation to pay, cash;
(b) assets to be acquired and liabilities to be incurred as a result of a firm commitment
to purchase or sell goods or services are not recognized under present accounting practice
until at least one of the parties has performed under the agreement such that it either is
entitled to receive an asset or is obligated to disburse an asset. For example, an
enterprise that receives a firm order does not recognize an asset (and the enterprise that
places the order does not recognize a liability) at the time of the commitment but,
rather, delays recognition until the ordered goods or services have been shipped,
delivered, or rendered;
(c) in contrast to (b) above, however, a forward contract - a commitment to purchase or
sell a specified financial instrument or commodity subject to this Standard on a future
date at a specified price - is recognized as an asset or a liability on the commitment
date, rather than waiting until the closing date on which the exchange actually takes
place. When an enterprise becomes a party to a forward contract, the fair values of the
right and obligation are often equal, so that the net fair value of the forward is zero,
and only any net fair value of the right and obligation is recognized as an asset or
liability. However, each party is exposed to the price risk that is the subject of the
contract from that date. Such a forward contract satisfies the recognition principle of
paragraph 27, from the perspectives of both the buyer and the seller, at the time the
enterprises become parties to the contract, even though it may have a zero net value at
that date. The fair value of the contract may become a net asset or liability in the
future depending on, among other things, the time value of money and the value of the
underlying instrument or commodity that is the subject of the forward;
(d) financial options are recognized as assets or liabilities when the holder or writer
becomes a party to the contract; and
(e) planned future transactions, no matter how likely, are not assets and liabilities of
an enterprise since the enterprise, as of the financial reporting date, has not become a
party to a contract requiring future receipt or delivery of assets arising out of the
future transactions.
Trade Date vs. Settlement Date
30. A 'regular way' purchase of financial assets should be recognized using trade date accounting or settlement date accounting described in paragraphs 32 and 33. The method used should be applied consistently for each of the four categories of financial assets defined in paragraph 10. A 'regular way' sale of financial assets should be recognized using settlement date accounting.
31. A contract for the purchase or sale of financial assets that requires delivery of the assets within the time frame generally established by regulation or convention in the market place concerned (sometimes called a 'regular way' contract) is a financial instrument as described in this Standard. The fixed price commitment between trade date and settlement date meets the definition of a derivative - it is a forward contract. However, because of the short duration of the commitment, such a contract is not recognized as a derivative financial instrument under this Standard.
32. The trade date is the date that an enterprise commits to purchase the asset. Trade date accounting refers to the recognition of the asset to be received and the liability to pay for it on the trade date. Generally, interest does not start to accrue on the asset and corresponding liability until the settlement date when title passes.
33. The settlement date is the date that the asset is delivered to the enterprise. Settlement date accounting refers to the recognition of the asset on the day it is transferred to the enterprise. When settlement date accounting is applied, under paragraph 106 an enterprise will account for any change in the fair value of the asset to be received during the period between the trade date and the settlement date in the same way as it will account for the acquired asset under this Standard. That is, the value change is not recognized for assets carried at cost or amortized cost; it is recognized in net profit or loss for assets classified as trading; and it is recognized in net profit or loss or in equity (as appropriate under paragraph 103) for assets classified as available for sale.
34. The following example illustrates the application of paragraphs 30-33 and later
parts of this Standard that specify measurement and recognition of changes in fair values
for various types of financial assets. On 29 December 20x1, an enterprise commits to
purchase a financial asset for 1,000 (including transaction costs), which is its fair
value on commitment (trade) date. On 31 December 20x1 (financial year end) and on 4
January 20x2 (settlement date) the fair value of the asset is 1,002 and 1,003,
respectively. The amounts to be recorded for the asset will depend on how it is classified
and whether trade date or settlement date accounting is used, as shown in the two tables
below:
Settlement Date Accounting
Assets Held
for Trading and
Available-for- Available-for-
Held-to- Sale Assets - Sale Assets -
Maturity Remeasured Remeasured
Investments - to Fair to Fair
Carried at Value with Value with
Amortized Changes in Changes in
Balances Cost Equity Profit or Loss
29 December 20x1
Financial asset -- -- --
Liability -- -- --
31 December 20x1
Receivable -- 2 2
Financial asset -- -- --
Liability -- -- --
Equity (fair
value adjustment) -- ( 2) --
Retained earnings
(through net
profit or loss) -- -- ( 2)
4 January 20x2
Receivable -- -- --
Financial asset 1,000 1,003 1,003
Liability -- -- --
Equity (fair
value adjustment) -- ( 3) --
Retained earnings
(through net
profit or loss) -- -- (3)
Trade Date Accounting
Assets Held
for Trading and
Available-for- Available-for-
Held-to- Sale Assets - Sale Assets -
Maturity Remeasured Remeasured
Investments - to Fair to Fair
Carried at Value with Value with
Amortized Changes in Changes in
Balances Cost Equity Profit or Loss
29 December 20x1
Financial asset 1,000 1,000 1,000
Liability (1,000) (1,000) (1,000)
31 December 20x1
Receivable -- -- --
Financial asset 1,000 1,002 1,002
Liability (1,000) (1,000) (1,000)
Equity (fair
value adjustment) -- (2) --
Retained earnings
(through net
profit or loss) -- -- (2)
4 January 20x2
Receivable -- -- --
Financial asset 1,000 1,003 1,003
Liability -- -- --
Equity (fair
value adjustment) -- (3) --
Retained earnings
(through net
profit or loss) -- -- (3)
Derecognition of a Financial Asset
35. An enterprise should derecognize a financial asset or a portion of a financial asset when, and only when, the enterprise loses control of the contractual rights that comprise the financial asset (or a portion of the financial asset). An enterprise loses such control if it realizes the rights to benefits specified in the contract, the rights expire, or the enterprise surrenders those rights.
36. If a financial asset is transferred to another enterprise but the transfer does not satisfy the conditions for derecognition in paragraph 35, the transferor accounts for the transaction as a collateralized borrowing. In that case, the transferor's right to reacquire the asset is not a derivative.
37. Determining whether an enterprise has lost control of a financial asset depends both on the enterprise's position and that of the transferee. Consequently, if the position of either enterprise indicates that the transferor has retained control, the transferor should not remove the asset from its balance sheet.
38. A transferor has not lost control of a transferred financial asset and, therefore,
the asset is not derecognized if, for example:
(a) the transferor has the right to reacquire the transferred asset unless either (i) the
asset is readily obtainable in the market or (ii) the reacquisition price is fair value at
the time of reacquisition;
(b) the transferor is both entitled and obligated to repurchase or redeem the transferred
asset on terms that effectively provide the transferee with a lender's return on the
assets received in exchange for the transferred asset. A lender's return is one that is
not materially different from that which could be obtained on a loan to the transferor
that is fully secured by the transferred asset; or
(c) the asset transferred is not readily obtainable in the market and the transferor has
retained substantially all of the risks and returns of ownership through a total return
swap with the transferee or has retained substantially all of the risks of ownership
through an unconditional put option on the transferred asset held by the transferee (a
total return swap provides the market returns and credit risks to one of the parties in
return for an interest index to the other party, such as a LIBOR payment).
39. Under paragraph 38(a), a transferred asset is not derecognized if the transferor has the right to repurchase the asset at a fixed price and the asset is not readily obtainable in the market, because the fixed price is not necessarily fair value at the time of reacquisition. For instance, a transfer of a group of mortgage loans that gives the transferor the right to reacquire those same loans at a fixed price would not result in derecognition.
40. A transferor may be both entitled and obligated to repurchase or redeem an asset by (a) a forward purchase contract, (b) a call option held and a put option written with approximately the same strike price, or (c) in other ways. However, neither the forward purchase contract in (a) nor the combination of options in (b) is sufficient, by itself, to maintain control over a transferred asset if the repurchase price is fair value at the time of repurchase.
41. A transferor generally has lost control of a transferred financial asset only if
the transferee has the ability to obtain the benefits of the transferred asset. That
ability is demonstrated, for example, if the transferee:
(a) is free either to sell or to pledge approximately the full fair value of the
transferred asset; or
(b) is a special-purpose entity whose permissible activities are limited, and either the
special purpose entity itself or the holders of beneficial interests in that entity have
the ability to obtain substantially all of the benefits of the transferred asset.4
That ability may be demonstrated in other ways.
42. Neither paragraph 38 nor paragraph 41 is viewed in isolation. For example, a bank transfers a loan to another bank, but to preserve the relationship of the transferor bank with its customer, the acquiring bank is not allowed to sell or pledge the loan. Although the inability to sell or pledge would suggest that the transferee has not obtained control, in this instance the transfer is a sale provided that the transferor does not have the right or ability to reacquire the transferred asset.
43. On derecognition, the difference between (a) the carrying amount of an asset (or portion of an asset) transferred to another party and (b) the sum of (i) the proceeds received or receivable and (ii) any prior adjustment to reflect the fair value of that asset that had been reported in equity should be included in net profit or loss for the period.
Accounting for Collateral
44. If a debtor delivers collateral to the creditor and the creditor is
permitted to sell or repledge the collateral without constraints, then:
(a) the debtor should disclose the collateral separately from other assets not used as
collateral; and
(b) the creditor should recognize the collateral in its balance sheet as an asset,
measured initially at its fair value, and should also recognize its obligation to return
the collateral as a liability.
45. If the creditor is constrained from selling or repledging the collateral because the debtor has the right and ability to redeem the collateral on short notice, for example, by substituting other collateral or by terminating the contract, then the creditor does not recognize the collateral in its balance sheet.
46. To illustrate application of paragraph 44, if A transfers and delivers certain
securities to B but the transaction does not qualify for derecognition on A's books, and B
takes possession of the collateral and is free to sell or pledge it, the following journal
entries would be made to reflect the collateral:
A's Books (the 'borrower'): Debit Credit
Securities given as collateral xx
Securities xx
To separate the collateralized asset
from unrestricted assets.
Cash xx
Liability xx
To record the collateralized borrowing.
B's Books (the 'lender'): Debit Credit
Securities held as collateral xx
Obligation to return securities xx
To reflect B's control of the asset and its
obligation to return them to A.
Receivable xx
Cash xx
To record the collateralized lending.
Derecognition of Part of a Financial Asset
47. If an enterprise transfers a part of a financial asset to others while retaining a part, the carrying amount of the financial asset should be allocated between the part retained and the part sold based on their relative fair values on the date of sale. A gain or loss should be recognized based on the proceeds for the portion sold. In the rare circumstance that the fair value of the part of the asset that is retained cannot be measured reliably, then that asset should be recorded at zero. The entire carrying amount of the financial asset should be attributed to the portion sold, and a gain or loss should be recognized equal to the difference between (a) the proceeds and (b) the previous carrying amount of the financial asset plus or minus any prior adjustment that had been reported in equity to reflect the fair value of that asset (a 'cost recovery' approach).
48. Examples of paragraph 47 are:
(a) separating the principal and interest cash flows of a bond and selling some of them to
another party while retaining the rest; and
(b) selling a portfolio of receivables while retaining the right to service the
receivables profitably for a fee, resulting in an asset for the servicing right (see
paragraph 50).
49. To illustrate application of paragraph 47, assume receivables with a carrying amount of 100 are sold for 90. The selling enterprise retains the right to service those receivables for a fee that is expected to exceed the cost of servicing, but the fair value of the servicing right cannot be measured reliably. In that case, a loss of 10 would be recognized and the servicing right would be recorded at zero.
50. This example illustrates how a transferor accounts for a sale or securitization in
which servicing is retained. An enterprise originates 1,000 of loans that yield 10 per
cent interest for their estimated lives of 9 years. The enterprise sells the 1,000
principal plus the right to receive interest income of 8 per cent to another enterprise
for 1,000. The transferor will continue to service the loans, and the contract stipulates
that its compensation for performing the servicing is the right to receive half of the
interest income not sold (that is, 100 of the 200 basis points). The remaining half of the
interest income not sold is considered an interest-only strip receivable. At the date of
the transfer, the fair value of the loans, including servicing, is 1,100, of which the
fair value of the servicing asset is 40 and the fair value of the interest-only strip
receivable is 60. Allocation of the 1,000 carrying amount of the loan is computed as
follows:
Percentage Allocated
of Total Carrying
Fair Value Fair Value Amount
Loans sold 1,000 91.0% 910
Servicing asset 40 3.6 36
Interest-only
strip receivable 60 5.4 _ 54
Total 1,100 100.0% 1,000
The transferor will recognize a gain of 90 on the sale of the loan - the difference
between the net proceeds of 1,000 and the allocated carrying amount of 910. Its balance
sheet will also report a servicing asset of 36 and an interest-only strip receivable of
54. The servicing asset is an intangible asset subject to the provisions of IAS 38,
Intangible Assets.
Asset Derecognition Coupled with a New Financial Asset or Liability
51. If an enterprise transfers control of an entire financial asset but, in
doing so, creates a new financial asset or assumes a new financial liability, the
enterprise should recognize the new financial asset or financial liability at fair value
and should recognize a gain or loss on the transaction based on the difference between:
(a) the proceeds; and
(b) the carrying amount of the financial asset sold plus the fair value of any new
financial liability assumed, minus the fair value of any new financial asset acquired, and
plus or minus any adjustment that had previously been reported in equity to reflect the
fair value of that asset.
52. Examples of paragraph 51 are:
(a) selling a portfolio of receivables while assuming an obligation to compensate the
purchaser of the receivables if collections are below a specified level; and
(b) selling a portfolio of receivables while retaining the right to service the
receivables for a fee, and the fee to be received is less than the costs of servicing,
thereby resulting in a liability for the servicing obligation.
53. The following example illustrates application of paragraph 51. A transfers certain
receivables to B for a single, fixed cash payment. A is not obligated to make future
payments of interest on the cash it has received from B. However, A guarantees B against
default loss on the receivables up to a specified amount. Actual losses in excess of the
amount guaranteed will be borne by B. As a result of the transaction, A has lost control
over the receivables and B has obtained control. B now has the contractual right to
receive cash inherent in the receivables as well as a guarantee from A. Under paragraph
51:
(a) B recognizes the receivables on its balance sheet, and A removes the receivables from
its balance sheet because they were sold to B; and
(b) the guarantee is treated as a separate financial instrument, created as a result of
the transfer, to be recognized as a financial liability by A and a financial asset by B.
For practical purposes, B might include the guarantee asset with the receivables.
54. In the rare circumstance that the fair value of the new financial asset or
new financial liability cannot be measured reliably, then:
(a) if a new financial asset is created but cannot be measured reliably, its initial
carrying amount should be zero, and a gain or loss should be recognized equal to the
difference between (i) the proceeds and (ii) the previous carrying amount of the
derecognized financial asset plus or minus any prior adjustment that had been reported in
equity to reflect the fair value of that asset; and
(b) if a new financial liability is assumed but cannot be measured reliably, its initial
carrying amount should be such that no gain is recognized on the transaction and, if IAS
37, Provisions, Contingent Liabilities and Contingent Assets, requires recognition of a
provision, a loss should be recognized.
Paragraphs 95-102 provide guidance as to when fair value is reliably measurable.
55. To illustrate paragraph 54(b), the excess of the proceeds over the carrying amount is not recognized in net profit or loss. Instead it is recorded as a liability in the balance sheet.
56. If a guarantee is recognized as a liability under this Standard, it continues to be recognized as a liability of the guarantor, measured at its fair value (or at the greater of its original recorded amount and any provision required by IAS 37, if fair value cannot be reliably measured), until it expires. If the guarantee involves a large population of items, the guarantee should be measured by weighting all possible outcomes by their associated probabilities.
Derecognition of a Financial Liability
57. An enterprise should remove a financial liability (or a part of a financial liability) from its balance sheet when, and only when, it is extinguished - that is, when the obligation specified in the contract is discharged, cancelled, or expires.
58. The condition in paragraph 57 is met when either:
(a) the debtor discharges the liability by paying the creditor, normally with cash, other
financial assets, goods, or services; or
(b) the debtor is legally released from primary responsibility for the liability (or part
thereof) either by process of law or by the creditor (the fact that the debtor may have
given a guarantee does not necessarily mean that this condition is not met).
59. Payment to a third party including a trust (sometimes called 'in-substance defeasance') does not by itself relieve the debtor of its primary obligation to the creditor, in the absence of legal release.
60. While legal release, whether judicially or by the creditor, will result in derecognition of a liability, the enterprise may have to recognize a new liability if the derecognition criteria in paragraphs 35-57 are not met for the non-cash financial assets that were transferred. If those criteria are not met, the transferred assets are not removed from the transferor's balance sheet, and the transferor recognizes a new liability relating to the transferred assets that may be equal to the derecognized liability.
61. An exchange between an existing borrower and lender of debt instruments with substantially different terms is an extinguishment of the old debt that should result in derecognition of that debt and recognition of a new debt instrument. Similarly, a substantial modification of the terms of an existing debt instrument (whether or not due to the financial difficulty of the debtor) should be accounted for as an extinguishment of the old debt.
62. For the purpose of paragraph 61, the terms are substantially different if the discounted present value of the cash flows under the new terms, including any fees paid net of any fees received, is at least 10 per cent different from the discounted present value of the remaining cash flows of the original debt instrument. If an exchange of debt instruments or modification of terms is accounted for as an extinguishment, any costs or fees incurred are recognized as part of the gain or loss on the extinguishment. If the exchange or modification is not accounted for as an extinguishment, any costs or fees incurred are an adjustment to the carrying amount of the liability and are amortized over the remaining term of the modified loan.
63. The difference between the carrying amount of a liability (or part of a liability) extinguished or transferred to another party, including related unamortized costs, and the amount paid for it should be included in net profit or loss for the period.
64. In some cases, a creditor releases a debtor from its present obligation to make
payments, but the debtor assumes an obligation to pay if the party assuming primary
responsibility defaults. In this circumstance the debtor:
(a) recognizes a new financial liability based on the fair value of its obligation for the
guarantee; and
(b) recognizes a gain or loss based on the difference between (i) any proceeds and (ii)
the carrying amount of the original financial liability (including any related unamortized
costs) minus the fair value of the new financial liability.
Derecognition of Part of a Financial Liability or Coupled with a New Financial Asset or Liability
65. If an enterprise transfers a part of a financial liability to others while retaining a part, or if an enterprise transfers an entire financial liability and in so doing creates a new financial asset or assumes a new financial liability, the enterprise should account for the transaction in the manner set out in paragraphs 47-56.
Initial Measurement of Financial Assets and Financial Liabilities
66. When a financial asset or financial liability is recognized initially, an enterprise should measure it at its cost, which is the fair value of the consideration given (in the case of an asset) or received (in the case of a liability) for it. Transaction costs are included in the initial measurement of all financial assets and liabilities.
67. The fair value of the consideration given or received normally is determinable by reference to the transaction price or other market prices. If such market prices are not reliably determinable, the fair value of the consideration is estimated as the sum of all future cash payments or receipts, discounted, if the effect of doing so would be material, using the prevailing market rate(s) of interest for a similar instrument (similar as to currency, term, type of interest rate, and other factors) of an issuer with a similar credit rating (see IAS 18, Revenue, paragraph 11). As an exception to paragraph 66, paragraph 160 requires that certain hedging gains and losses be included as part of the initial measurement of the cost of the related hedged asset.
Subsequent Measurement of Financial Assets
68. For the purpose of measuring a financial asset subsequent to initial recognition,
this Standard classifies financial assets into four categories:
(a) loans and receivables originated by the enterprise and not held for trading;
(b) held-to-maturity investments;
(c) available-for-sale financial assets; and
(d) financial assets held for trading.
69. After initial recognition, an enterprise should measure financial assets,
including derivatives that are assets, at their fair values, without any deduction for
transaction costs that it may incur on sale or other disposal, except for the following
categories of financial assets, which should be measured under paragraph 73:
(a) loans and receivables originated by the enterprise and not held for trading;
(b) held-to-maturity investments; and
(c) any financial asset that does not have a quoted market price in an active market and
whose fair value cannot be reliably measured (see paragraph 70).
Financial assets that are designated as hedged items are subject to measurement under the
hedge accounting provisions in paragraphs 121-165 of this Standard.
70. There is a presumption that fair value can be reliably determined for most financial assets classified as available for sale or held for trading. However, that presumption can be overcome for an investment in an equity instrument (including an investment that is in substance an equity instrument - see paragraph 71) that does not have a quoted market price in an active market and for which other methods of reasonably estimating fair value are clearly inappropriate or unworkable. The presumption can also be overcome for a derivative that is linked to and that must be settled by delivery of such an unquoted equity instrument. See paragraphs 95-102 for guidance on estimating fair value.
71. An example of an investment that is in substance an equity instrument is special participation rights without a specified maturity whose return is linked to an enterprise's performance.
72. If a financial asset is required to be measured at fair value and its fair value is below zero, it is accounted for as a financial liability as set out in paragraph 93.
73. Those financial assets that are excluded from fair valuation under paragraph 69 and that have a fixed maturity should be measured at amortized cost using the effective interest rate method. Those that do not have a fixed maturity should be measured at cost. All financial assets are subject to review for impairment as set out in paragraphs 109-119.
74. Short-duration receivables with no stated interest rate are normally measured at original invoice amount unless the effect of imputing interest would be significant.
75. Loans and receivables originated by an enterprise and not held for trading are measured at amortized cost without regard to the enterprise's intent to hold them to maturity.
76. For floating rate financial instruments, periodic re-estimation of determinable cash flows to reflect movements in market rates of interest changes the effective yield on a monetary financial asset. Such changes in cash flows are recognized over the remaining term of the asset, or the next repricing date if the asset reprices at market. In the case of a floating rate financial asset recognized initially at an amount equal to the principal repayable on maturity, re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset.
77. The following example illustrates how transaction costs relate to the initial and subsequent measurement of a financial asset held for trading. An asset is acquired for 100 plus a purchase commission of 2. Initially it is recorded at 102. At the next financial reporting date, the quoted market price of the asset remains at 100. If the asset were sold, a commission of 3 would be paid. In that case, the asset is measured at 100 (without regard to the possible commission on sale) and a loss of 2 is recognized in net profit or loss for the period.
78. An enterprise applies IAS 21, The Effects of Changes in Foreign Exchange Rates, to financial assets that are monetary items under IAS 21 and that are denominated in a foreign currency. Under IAS 21, any foreign exchange gains and losses on monetary assets are reported in net profit or loss. An exception is a monetary item that is designated as a hedging instrument in a cash flow hedge (see paragraphs 121-165). Any recognized change in the fair value of such a monetary item apart from foreign exchange gains and losses is accounted for under paragraph 103. With respect to financial assets that are not monetary items under IAS 21 (for example, equity instruments), any recognized change in fair value, including any component of that change that may relate to changes in foreign exchange rates, is accounted for under paragraph 103. Under the hedge accounting provisions of this Standard (paragraphs 121-165), if there is a hedging relationship between a non-derivative monetary asset and a non-derivative monetary liability, changes in the fair values of those financial instruments are reported in net profit or loss.
Held-to-Maturity Investments
79. An enterprise does not have the positive intent to hold to maturity an
investment in a financial asset with a fixed maturity if any one of the following
conditions is met:
(a) the enterprise has the intent to hold the financial asset for only an undefined
period;
(b) the enterprise stands ready to sell the financial asset (other than if a situation
arises that is non-recurring and could not have been reasonably anticipated by the
enterprise) in response to changes in market interest rates or risks, liquidity needs,
changes in the availability of and the yield on alternative investments, changes in
financing sources and terms, or changes in foreign currency risk; or
(c) the issuer has a right to settle the financial asset at an amount significantly below
its amortized cost.
80. A debt security with a variable interest rate can satisfy the criteria for a held-to-maturity investment. Most equity securities cannot be held-to-maturity investments either because they have an indefinite life (such as ordinary shares) or because the amounts the holder may receive can vary in a manner that is not predetermined (such as share options, warrants, and rights). With respect to held-to-maturity investments, fixed or determinable payments and fixed maturity means a contractual arrangement that defines the amounts and dates of payments to the holder, such as interest and principal payments on debt.
81. A financial asset that is callable by the issuer satisfies the criteria for a held-to-maturity investment if the holder intends and is able to hold it until it is called or until maturity and if the holder would recover substantially all of its carrying amount. The call option, if exercised, simply accelerates the asset's maturity. However, if the financial asset is callable in a manner such that the holder would not recover substantially all of its carrying amount, the financial asset is not classified as held-to-maturity. The enterprise considers any premium paid and capitalized transaction costs in determining whether the carrying amount would be substantially recovered.
82. A financial asset that is puttable (the holder has the right to require that the issuer repay or redeem the financial asset before maturity) is classified as a held-to-maturity investment only if the holder has the positive intent and ability to hold it until maturity and not to exercise the put feature.
83. An enterprise should not classify any financial assets as held-to-maturity
if the enterprise has, during the current financial year or during the two preceding
financial years, sold, transferred, or exercised a put option on more than an
insignificant amount of held-to-maturity investments before maturity (more than
insignificant in relation to the total held-to-maturity portfolio) other than by:
(a) sales close enough to maturity or exercised call date so that changes in the market
rate of interest did not have a significant effect on the financial asset's fair
value;
(b) sales after the enterprise has already collected substantially all of the financial
asset's original principal through scheduled payments or prepayments; or
(c) sales due to an isolated event that is beyond the enterprise's control and that is
non-recurring and could not have been reasonably anticipated by the enterprise.
Paragraphs 90-92 address reclassifications between fair value and amortized cost.
84. Under this Standard, fair value is a more appropriate measure for most financial assets than amortized cost. The held-to-maturity classification is an exception, but only if the enterprise has the positive intent and ability to hold the investment to maturity. When an enterprise's actions have cast doubt on its intent and ability to hold such investments to maturity, paragraph 83 precludes the exception for a reasonable period of time.
85. A 'disaster scenario' that is extremely remote, such as a run on a bank or a similar situation affecting an insurance company, is not anticipated by an enterprise in deciding whether it has the positive intent and ability to hold an investment to maturity.
86. Sales before maturity could satisfy the condition in paragraph 83 - and therefore
not raise a question about the enterprise's intent to hold other investments to maturity -
if they are due to:
(a) a significant deterioration in the issuer's creditworthiness;
(b) a change in tax law that eliminates or significantly reduces the tax-exempt status of
interest on the held-to-maturity investment (but not a change in tax law that revises the
marginal tax rates applicable to interest income);
(c) a major business combination or major disposition (such as sale of a segment) that
necessitates the sale or transfer of held-to-maturity investments to maintain the
enterprise's existing interest rate risk position or credit risk policy (although the
business combination itself is an event within the enterprise's control, the changes to
its investment portfolio to maintain interest rate risk position or credit risk policy may
be consequential rather than anticipated);
(d) a change in statutory or regulatory requirements significantly modifying either what
constitutes a permissible investment or the maximum level of certain kinds of investments,
thereby causing an enterprise to dispose of a held-to-maturity investment;
(e) a significant increase by the regulator in the industry's capital requirements that
causes the enterprise to downsize by selling held-to-maturity investments; or
(f) a significant increase in the risk weights of held-to-maturity investments used for
regulatory risk-based capital purposes.
87. An enterprise does not have a demonstrated ability to hold to maturity an
investment in a financial asset with a fixed maturity if either one of the following
conditions is met:
(a) it does not have the financial resources available to continue to finance the
investment until maturity; or
(b) it is subject to an existing legal or other constraint that could frustrate its
intention to hold the financial asset to maturity (however, an issuer's call option does
not necessarily frustrate an enterprise's intent to hold a financial asset to maturity -
see paragraph 81).
88. Circumstances other than those described in paragraphs 79-87 can indicate that an enterprise does not have a positive intent or ability to hold an investment to maturity.
89. An enterprise assesses its intent and ability to hold its held-to-maturity investments to maturity not only when those financial assets are initially acquired but also at each balance sheet date.
90. If, due to a change of intent or ability, it is no longer appropriate to carry a held-to-maturity investment at amortized cost, it should be remeasured at fair value, and the difference between its carrying amount and fair value should be accounted for in accordance with paragraph 103.
91. Similarly, if a reliable measure becomes available for a financial asset for which such a measure previously was not available, the asset should be remeasured at fair value, and the difference between its carrying amount and fair value should be accounted for in accordance with paragraph 103.
92. If, due to a change of intent or ability or in the rare circumstance that a
reliable measure of fair value is no longer available or because the 'two preceding
financial years' referred to in paragraph 83 have now passed, it becomes appropriate to
carry a financial asset at amortized cost rather than at fair value, the fair value
carrying amount of the financial asset on that date becomes its new amortized cost. Any
previous gain or loss on that asset that has been recognized directly in equity in
accordance with paragraph 103 should be accounted for as follows:
(a) in the case of a financial asset with a fixed maturity, a previous gain or loss on
that asset that has been recognized directly in equity should be amortized over the
remaining life of the held-to-maturity investment. Any difference between the new
amortized cost and maturity amount should be amortized over the remaining life of the
financial asset as an adjustment of yield, similar to amortization of premium and
discount; and
(b) in the case of a financial asset that does not have a fixed maturity, a previous gain
or loss on that asset that has been recognized directly in equity should be left in equity
until the financial asset has been sold or otherwise disposed of, at which time it should
enter into the determination of net profit or loss.
Subsequent Measurement of Financial Liabilities
93. After initial recognition, an enterprise should measure all financial liabilities, other than liabilities held for trading and derivatives that are liabilities, at amortized cost. After initial recognition, an enterprise should measure liabilities held for trading and derivatives that are liabilities at fair value, except for a derivative liability that is linked to and that must be settled by delivery of an unquoted equity instrument whose fair value cannot be reliably measured, which should be measured at cost. Financial liabilities that are designated as hedged items are subject to measurement under the hedge accounting provisions in paragraphs 121-165 of this Standard.
94. An enterprise applies IAS 21, The Effects of Changes in Foreign Exchange Rates, to financial liabilities that are monetary items under IAS 21 and that are denominated in a foreign currency. Under IAS 21, any foreign exchange gains and losses on monetary liabilities are reported in net profit or loss. An exception is a monetary item that is designated as a hedging instrument in a cash flow hedge (see paragraphs 121-165). Any recognized change in the fair value of such a monetary item apart from foreign exchange gains and losses is accounted for under paragraph 103. With respect to financial liabilities that are not monetary items under IAS 21 (such as some mandatorily redeemable preferred stock issued by the enterprise), any recognized change in fair value, including any component of that change that may relate to changes in foreign exchange rates, is accounted for under paragraph 103. Under the hedge accounting provisions of this Standard (paragraphs 121-165), if there is a hedging relationship between a non-derivative monetary asset and a non-derivative monetary liability, changes in the fair values of those financial instruments will be reported in net profit or loss.
Fair Value Measurement Considerations
95. The fair value of a financial instrument is reliably measurable if (a) the variability in the range of reasonable fair value estimates is not significant for that instrument or (b) if the probabilities of the various estimates within the range can be reasonably assessed and used in estimating fair value. Often, an enterprise will be able to make an estimate of the fair value of a financial instrument that is sufficiently reliable to use in financial statements. Occasionally, the variability in the range of reasonable fair value estimates is so great and the probabilities of the various outcomes are so difficult to assess that the usefulness of a single estimate of fair value is negated.
96. Situations in which fair value is reliably measurable include (a) a financial instrument for which there is a published price quotation in an active public securities market for that instrument, (b) a debt instrument that has been rated by an independent rating agency and whose cash flows can be reasonably estimated, and (c) a financial instrument for which there is an appropriate valuation model and for which the data inputs to that model can be measured reliably because the data come from active markets.
97. The fair value of a financial asset or financial liability may be determined by one of several generally accepted methods. Valuation techniques should incorporate the assumptions that market participants would use in their estimates of fair values, including assumptions about prepayment rates, rates of estimated credit losses, and interest or discount rates. Paragraph 167(a) requires disclosure of the methods and significant assumptions applied in estimating fair values.
98. Underlying the definition of fair value is a presumption that an enterprise is a going concern without any intention or need to liquidate, curtail materially the scale of its operations, or undertake a transaction on adverse terms. Fair value is not, therefore, the amount that an enterprise would receive or pay in a forced transaction, involuntary liquidation, or distress sale. However, an enterprise takes its current circumstances into account in determining the fair values of its financial assets and financial liabilities. For example, the fair value of a financial asset that an enterprise has decided to sell for cash in the immediate future is determined by the amount that it expects to receive from such a sale. The amount of cash to be realized from an immediate sale will be affected by factors such as the current liquidity and depth of the market for the asset.
99. The existence of published price quotations in an active market is normally the best evidence of fair value. The appropriate quoted market price for an asset held or liability to be issued is usually the current bid price and, for an asset to be acquired or liability held, the current offer or asking price. When current bid and offer prices are unavailable, the price of the most recent transaction may provide evidence of the current fair value provided that there has not been a significant change in economic circumstances between the transaction date and the reporting date. When an enterprise has matching asset and liability positions, it may appropriately use mid-market prices as a basis for establishing fair values.
100. If the market for a financial instrument is not an active market, published price quotations may have to be adjusted to arrive at a reliable measure of fair value. If there is infrequent activity in a market, the market is not well established (for example, some 'over the counter' markets) or small volumes are traded relative to the number of trading units of a financial instrument to be valued, quoted market prices may not be indicative of the fair value of the instrument. In some cases where the volume traded is relatively small, a price quotation for a larger block may be available from the market maker in that instrument. In other circumstances, as well as when a quoted market price is not available, estimation techniques may be used to determine fair value with sufficient reliability to satisfy the requirements of this Standard. Techniques that are well established in financial markets include reference to the current market value of another instrument that is substantially the same, discounted cash flow analysis, and option pricing models. In applying discounted cash flow analysis, an enterprise uses the discount rate(s) equal to the prevailing rate of return for financial instruments having substantially the same terms and characteristics, including the creditworthiness of the debtor, the remaining term over which the contractual interest rate is fixed, the remaining term to repayment of the principal, and the currency in which payments are to be made.
101. If a market price does not exist for a financial instrument in its entirety but markets exist for its component parts, fair value is constructed on the basis of the relevant market prices. If a market does not exist for a financial instrument but a market exists for a similar financial instrument, fair value is constructed on the basis of the market price of the similar financial instrument.
102. There are many situations other than those enumerated in paragraphs 95-101 in which the variability in the range of reasonable fair value estimates is likely not to be significant. It is normally possible to estimate the fair value of a financial asset that an enterprise has acquired from an outside party. An enterprise is unlikely to purchase a financial instrument for which it does not expect to be able to obtain a reliable measure of fair value after acquisition. The IASC Framework states: 'In many cases, cost or value must be estimated; the use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability.'
Gains and Losses on Remeasurement to Fair Value
103. A recognized gain or loss arising from a change in the fair value of a
financial asset or financial liability that is not part of a hedging relationship (see
paragraphs 121-165) should be reported as follows:
(a) a gain or loss on a financial asset or liability held for trading should be included
in net profit or loss for the period in which it arises (in this regard, a derivative
should always be considered to be held for trading unless it is a designated hedging
instrument - see paragraph 122);
(b) a gain or loss on an available-for-sale financial asset should be either:
(i) included in net profit or loss for the period in which it arises; or
(ii) recognized directly in equity, through the statement of changes in equity (see IAS 1,
Presentation of Financial Statements, paragraphs 86-88), until the financial asset is
sold, collected, or otherwise disposed of, or until the financial asset is determined to
be impaired (see paragraphs 117-119), at which time the cumulative gain or loss previously
recognized in equity should be included in net profit or loss for the period.
104. An enterprise should choose either paragraph 103(b)(i) or paragraph 103(b)(ii) as its accounting policy and should apply that policy to all of its available-for-sale financial assets (except for hedges - see paragraph 121).
105. IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies, provides that a voluntary change in accounting policy should be made only if the change will result in a more appropriate presentation of events or transactions in the financial statements of the enterprise. The Board believes that this is highly unlikely to be the case for a change from paragraph 103(b)(i) to paragraph 103(b)(ii).
106. If an enterprise recognizes purchases of financial assets using settlement date accounting (see paragraph 30), any change in the fair value of the asset to be received during the period between the trade date and the settlement date is not recognized for assets carried at cost or amortized cost (other than impairment losses). For assets remeasured to fair value, however, the change in fair value should be recognized in net profit or loss or in equity, as appropriate under paragraph 103.
107. Because the designation of a financial asset as held for trading is based on the objective for initially acquiring it, an enterprise should not reclassify its financial assets that are being remeasured to fair value out of the trading category while they are held. An enterprise should reclassify a financial asset into the trading category only if there is evidence of a recent actual pattern of short-term profit taking that justifies such reclassification (see paragraph 21).
Gains and Losses on Financial Assets and Liabilities Not Remeasured to Fair Value
108. For those financial assets and financial liabilities carried at amortized cost (paragraphs 73 and 93), a gain or loss is recognized in net profit or loss when the financial asset or liability is derecognized or impaired, as well as through the amortization process. However, if there is a hedging relationship between those financial assets or liabilities (the items being hedged) and a hedging instrument as described in paragraphs 121-152, accounting for the gain or loss should follow paragraphs 153-164.
Impairment and Uncollectability of Financial Assets
109. A financial asset is impaired if its carrying amount is greater than its estimated recoverable amount. An enterprise should assess at each balance sheet date whether there is any objective evidence that a financial asset or group of assets may be impaired. If any such evidence exists, the enterprise should estimate the recoverable amount of that asset or group of assets and recognize any impairment loss in accordance with paragraph 111 (for financial assets carried at amortized cost) or paragraph 117 (for financial assets remeasured to fair value).
110. Objective evidence that a financial asset or group of assets is impaired or
uncollectable includes information that comes to the attention of the holder of the asset
about:
(a) significant financial difficulty of the issuer;
(b) an actual breach of contract, such as a default or delinquency in interest or
principal payments;
(c) granting by the lender to the borrower, for economic or legal reasons relating to the
borrower's financial difficulty, of a concession that the lender would not otherwise
consider;
(d) a high probability of bankruptcy or other financial reorganization of the
issuer;
(e) recognition of an impairment loss on that asset in a prior financial reporting period;
(f) the disappearance of an active market for that financial asset due to financial
difficulties; or
(g) a historical pattern of collections of accounts receivable that indicates that the
entire face amount of a portfolio of accounts receivable will not be collected.
The disappearance of an active market because an enterprise's securities are no longer publicly traded is not evidence of impairment. A downgrade of an enterprise's credit rating is not, of itself, evidence of impairment, though it may be evidence of impairment when considered with other available information.
Financial Assets Carried at Amortized Cost
111. If it is probable that an enterprise will not be able to collect all amounts due (principal and interest) according to the contractual terms of loans, receivables, or held-to-maturity investments carried at amortized cost, an impairment or bad debt loss has occurred. The amount of the loss is the difference between the asset's carrying amount and the present value of expected future cash flows discounted at the financial instrument's original effective interest rate (recoverable amount). Cash flows relating to short-term receivables generally are not discounted (see paragraph 74). The carrying amount of the asset should be reduced to its estimated recoverable amount either directly or through use of an allowance account. The amount of the loss should be included in net profit or loss for the period.
112. Impairment and uncollectability may be measured and recognized individually for financial assets that are individually significant. Impairment and uncollectability may be measured and recognized on a portfolio basis for a group of similar financial assets.
113. Impairment of a financial asset carried at amortized cost is measured using the financial instrument's original effective interest rate because discounting at the current market rate of interest would, in effect, impose fair-value measurement on financial assets that this Standard would otherwise measure at amortized cost. If a loan, receivable, or held-to-maturity investment has a variable interest rate, the discount rate for measuring recoverable amount pursuant to paragraph 111 is the current effective interest rate(s) determined under the contract. As a surrogate for such a fair value calculation, a creditor may measure impairment based on an instrument's fair value using an observable market price. If an asset is collateralized and foreclosure is probable, then the holder measures impairment based on the fair value of the collateral.
114. If, in a subsequent period, the amount of the impairment or bad debt loss decreases and the decrease can be objectively related to an event occurring after the write-down (such as an improvement in the debtor's credit rating), the write-down of the financial asset should be reversed either directly or by adjusting an allowance account. The reversal should not result in a carrying amount of the financial asset that exceeds what amortized cost would have been, had the impairment not been recognized, at the date the write-down of the financial asset is reversed. The amount of the reversal should be included in net profit or loss for the period.
115. The carrying amount of any financial asset that is not carried at fair value because its fair value cannot be reliably measured (paragraph 69(c)) should be reviewed for an indication of impairment at each balance sheet date based on an analysis of expected net cash inflows. If there is an indication of impairment, the amount of the impairment loss of such a financial asset is the difference between its carrying amount and the present value of expected future cash flows discounted at the current market rate of interest for a similar financial asset (recoverable amount).
Interest Income After Impairment Recognition
116. Once a financial asset has been written down to its estimated recoverable amount, interest income is thereafter recognized based on the rate of interest that was used to discount the future cash flows for the purpose of measuring the recoverable amount. Additionally, after initially recognizing an impairment loss, the enterprise will review this asset for further impairment at subsequent financial reporting dates (see paragraph 110(e)). IAS 18 paragraph 30 provides guidance for recognizing interest income on unimpaired financial assets.
Financial Assets Remeasured to Fair Value
117. If a loss on a financial asset carried at fair value (recoverable amount is below original acquisition cost) has been recognized directly in equity in accordance with paragraph 103(b)(ii) and there is objective evidence (see paragraph 110) that the asset is impaired, the cumulative net loss that had been recognized directly in equity should be removed from equity and recognized in net profit or loss for the period even though the financial asset has not been derecognized.
118. The amount of the loss that should be removed from equity and reported in net profit or loss is the difference between its acquisition cost (net of any principal repayment and amortization) and current fair value (for equity instruments) or recoverable amount (for debt instruments), less any impairment loss on that asset previously recognized in net profit or loss. The recoverable amount of a debt instrument remeasured to fair value is the present value of expected future cash flows discounted at the current market rate of interest for a similar financial asset.
119. If, in a subsequent period, the fair value or recoverable amount of the financial asset carried at fair value increases and the increase can be objectively related to an event occurring after the loss was recognized in net profit or loss, the loss should be reversed, with the amount of the reversal included in net profit or loss for the period.
Fair Value Accounting in Certain Financial Services Industries
120. In some countries, either based on national law or accepted industry practice, enterprises in certain financial services industries measure substantially all financial assets at fair value. Examples of such industries include, in certain countries, mutual funds, unit trusts, securities brokers and dealers, and insurance companies. Under this Standard, such an enterprise will be able to continue to measure its financial assets at fair value if its financial assets are classified under this Standard as either available for sale or held for trading.
121. If there is a hedging relationship between a hedging instrument and a related item being hedged as described in paragraphs 122-152, accounting for the gain or loss should follow paragraphs 153-164.
122. This Standard does not restrict the circumstances in which a derivative may be designated as a hedging instrument, for hedge accounting purposes, if the conditions in paragraph 142 are met, except for certain written options (see paragraph 124). However, a non-derivative financial asset or liability may be designated as a hedging instrument, for hedge accounting purposes, only for a hedge of a foreign currency risk. The reason for this limitation is the different bases for measuring derivatives and non-derivatives. Under this Standard derivatives are always regarded as held for trading or hedging and, therefore, are (unless they are linked to and must be settled by delivery of an unquoted equity instrument whose fair value is not reliably measurable) remeasured to fair value, with changes in fair value included in net profit or loss, or in equity if the instrument is a cash flow hedge. Non-derivatives, on the other hand, are sometimes measured at fair value with changes in fair value included in net profit or loss, sometimes measured at fair value with changes in fair value reported in equity, and sometimes measured at amortized cost. To allow non-derivatives to be designated as hedging instruments in more than limited circumstances creates measurement inconsistencies.
123. An enterprise's own equity securities are not financial assets or financial liabilities of the enterprise and, therefore, are not hedging instruments.
124. Hedging involves a proportionate income offset between changes in fair value of, or cash flows attributable to, the hedging instrument and the hedged item. The potential loss on an option that an enterprise writes could be significantly greater than the potential gain in value of a related hedged item. That is, a written option is not effective in reducing the exposure on net profit or loss. Therefore, a written option is not a hedging instrument unless it is designated as an offset to a purchased option, including one that is embedded in another financial instrument, for example, a written option used to hedge callable debt. In contrast, a purchased option has potential gains equal to or greater than losses and, therefore, has the potential to reduce profit or loss exposure from changes in fair values or cash flows. Accordingly, it can qualify as a hedging instrument.
125. Held-to-maturity investments carried at amortized cost may be effective hedging instruments with respect to risks from changes in foreign currency exchange rates.
126. A financial asset or financial liability whose fair value cannot be reliably measured cannot be a hedging instrument except in the case of a nonderivative instrument (a) that is denominated in a foreign currency, (b) that is designated as a hedge of foreign currency risk, and (c) whose foreign currency component is reliably measurable.
127. A hedged item can be a recognized asset or liability, an unrecognized firm commitment, or an uncommitted but highly probable anticipated future transaction ('forecasted transaction'). The hedged item can be (a) a single asset, liability, firm commitment, or forecasted transaction or (b) a group of assets, liabilities, firm commitments, or forecasted transactions with similar risk characteristics. Unlike originated loans and receivables, a held-to-maturity investment cannot be a hedged item with respect to interest-rate risk because designation of an investment as held-to-maturity involves not accounting for associated changes in interest rates. However, a held-to-maturity investment can be a hedged item with respect to risks from changes in foreign currency exchange rates and credit risk.
128. If the hedged item is a financial asset or liability, it may be a hedged item with respect to the risks associated with only a portion of its cash flows or fair value, if effectiveness can be measured.
129. If the hedged item is a non-financial asset or liability, it should be designated as a hedged item either (a) for foreign currency risks or (b) in its entirety for all risks, because of the difficulty of isolating and measuring the appropriate portion of the cash flows or fair value changes attributable to specific risks other than foreign currency risks.
130. Because changes in the price of an ingredient or component of a non-financial asset or liability generally do not have a predictable, separately measurable effect on the price of the item that is comparable to the effect of, say, a change in market interest rates or the price of a bond, a non-financial asset or liability is a hedged item only in its entirety.
131. A single hedging instrument may be designated as a hedge of more than one type of risk provided that: (a) the risks hedged can be clearly identified, (b) the effectiveness of the hedge can be demonstrated, and (c) it is possible to ensure that there is a specific designation of the hedging instrument and the different risk positions.
132. If similar assets or similar liabilities are aggregated and hedged as a group, the individual assets or individual liabilities in the group will share the risk exposure for which they are designated as being hedged. Further, the change in fair value attributable to the hedged risk for each individual item in the group will be expected to be approximately proportional to the overall change in fair value attributable to the hedged risk of the group.
133. Because hedge effectiveness must be assessed by comparing the change in value or cash flow of a hedging instrument (or group of similar hedging instruments) and a hedged item (or group of similar hedged items), comparing a hedging instrument to an overall net position rather than to a specific hedged item (for example, the net of all fixed rate assets and fixed rate liabilities with similar maturities), does not qualify for hedge accounting. However, approximately the same effect on net profit or loss of hedge accounting for this kind of hedging relationship can be achieved by designating part of the underlying items as the hedged position. For example, if a bank has 100 of assets and 90 of liabilities with risks and terms of a similar nature and wishes to hedge the net 10 exposure, it can designate 10 of those assets as the hedged item. This designation could be used if such assets and liabilities are fixed rate instruments, in which case it is a fair value hedge, or if they are both variable rate instruments, in which case it is a cash flow hedge. Similarly, if an enterprise has a firm commitment to make a purchase in a foreign currency of 100 and a firm commitment to make a sale in the foreign currency of 90, it can hedge the net amount of 10 by acquiring a derivative and designating it as a hedging instrument associated with 10 of the firm purchase commitment of 100.
134. For hedge accounting purposes, only derivatives that involve a party external to the enterprise can be designated as hedging instruments. Although individual companies within a consolidated group or divisions within a company may enter into hedging transactions with other companies within the group or divisions within the company, any gains and losses on such transactions are eliminated on consolidation. Therefore, such intra-group or intra-company hedging transactions do not qualify for hedge accounting treatment in consolidation.
135. A firm commitment to acquire a business in a business combination cannot be a hedged item except with respect to foreign exchange risk because the other risks being hedged cannot be specifically identified and measured. It is a hedge of a general business risk.
136. Hedge accounting recognizes symmetrically the offsetting effects on net profit or loss of changes in the fair values of the hedging instrument and the related item being hedged.
137. Hedging relationships are of three types:
(a) fair value hedge: a hedge of the exposure to changes in the fair value of a
recognized asset or liability, or an identified portion of such an asset or liability,
that is attributable to a particular risk and that will affect reported net income;
(b) cash flow hedge: a hedge of the exposure to variability in cash flows that (i)
is attributable to a particular risk associated with a recognized asset or liability (such
as all or some future interest payments on variable rate debt) or a forecasted transaction
(such as an anticipated purchase or sale) and that (ii) will affect reported net profit or
loss. A hedge of an unrecognized firm commitment to buy or sell an asset at a fixed price
in the enterprise's reporting currency is accounted for as a cash flow hedge even though
it has a fair value exposure; and
(c) hedge of a net investment in a foreign entity as defined in IAS 21, The Effects
of Changes in Foreign Exchange Rates.
138. An example of a fair value hedge is a hedge of exposure to changes in the fair value of fixed rate debt as a result of changes in interest rates. Such a hedge could be entered into either by the issuer or by the holder.
139. Examples of cash flow hedges are:
(a) a hedge of the future foreign currency risk in an unrecognized contractual commitment
by an airline to purchase an aircraft for a fixed amount of a foreign currency;
(b) a hedge of the change in fuel price relating to an unrecognized contractual commitment
by an electric utility to purchase fuel at a fixed price, with payment in its domestic
currency; and
(c) use of a swap to, in effect, change floating rate debt to fixed rate debt (this is a
hedge of a future transaction; the future cash flows being hedged are the future interest
payments).
140. A hedge of a firm commitment in an enterprise's own reporting currency is not a hedge of a cash flow exposure but rather of an exposure to a change in fair value. Nonetheless, such a hedge is accounted for as a cash flow hedge under this Standard, rather than as a fair value hedge, to avoid recognizing as an asset or a liability a commitment that otherwise would not be recognized as an asset or liability under current accounting practice.
141. As defined in IAS 21, a foreign entity is a foreign operation, the activities of which are not an integral part of the reporting enterprise. Under IAS 21, all foreign exchange differences that result from translating the financial statements of the foreign entity into the parent's reporting currency are classified as equity until disposal of the net investment.
142. Under this Standard, a hedging relationship qualifies for special hedge
accounting as set out in paragraphs 153-164 if, and only if, all of the following
conditions are met:
(a) at the inception of the hedge there is formal documentation of the hedging
relationship and the enterprise's risk management objective and strategy for undertaking
the hedge. That documentation should include identification of the hedging instrument, the
related hedged item or transaction, the nature of the risk being hedged, and how the
enterprise will assess the hedging instrument's effectiveness in offsetting the exposure
to changes in the hedged item's fair value or the hedged transaction's cash flows that is
attributable to the hedged risk;
(b) the hedge is expected to be highly effective (see paragraph 146) in achieving
offsetting changes in fair value or cash flows attributable to the hedged risk, consistent
with the originally documented risk management strategy for that particular hedging
relationship;
(c) for cash flow hedges, a forecasted transaction that is the subject of the hedge must
be highly probable and must present an exposure to variations in cash flows that could
ultimately affect reported net profit or loss;
(d) the effectiveness of the hedge can be reliably measured, that is, the fair value or
cash flows of the hedged item and the fair value of the hedging instrument can be reliably
measured (see paragraph 95 for guidance on fair value); and
(e) the hedge was assessed on an ongoing basis and determined actually to have been highly
effective throughout the financial reporting period.
143. In the case of interest rate risk, hedge effectiveness may be assessed by preparing a maturity schedule that shows a reduction of all or part of the rate exposure, for each strip of maturity schedule, resulting from the aggregation of elements, the net position of which is hedged, providing such net exposure can be associated with an asset or liability giving rise to such net exposure and correlation can be assessed against that asset or liability.
144. There is normally a single fair value measure for a hedging instrument in its entirety, and the factors that cause changes in fair value are co-dependent. Thus a hedging relationship is designated by an enterprise for a hedging instrument in its entirety. The only exceptions permitted are (a) splitting the intrinsic value and the time value of an option and designating only the change in the intrinsic value of an option as the hedging instrument, while the remaining component of the option (its time value) is excluded and (b) splitting the interest element and the spot price on a forward. Those exceptions recognize that the intrinsic value of the option and the premium on the forward generally can be measured separately. A dynamic hedging strategy that assesses both the intrinsic and the time value of an option can qualify for hedge accounting.
145. A proportion of the entire hedging instrument, such as 50 per cent of the notional amount, may be designated in a hedging relationship. However, a hedging relationship may not be designated for only a portion of the time period in which a hedging instrument is outstanding.
Assessing Hedge Effectiveness
146. A hedge is normally regarded as highly effective if, at inception and throughout the life of the hedge, the enterprise can expect changes in the fair value or cash flows of the hedged item to be almost fully offset by the changes in the fair value or cash flows of the hedging instrument, and actual results are within a range of 80 per cent to 125 per cent. For example, if the loss on the hedging instrument is 120 and the gain on the cash instrument is 100, offset can be measured by 120/100, which is 120 per cent, or by 100/120, which is 83 per cent. The enterprise will conclude that the hedge is highly effective.
147. The method an enterprise adopts for assessing hedge effectiveness will depend on its risk management strategy. In some cases, an enterprise will adopt different methods for different types of hedges. If the principal terms of the hedging instrument and of the entire hedged asset or liability or hedged forecasted transaction are the same, the changes in fair value and cash flows attributable to the risk being hedged offset fully, both when the hedge is entered into and thereafter until completion. For instance, an interest rate swap is likely to be an effective hedge if the notional and principal amounts, term, repricing dates, dates of interest and principal receipts and payments, and basis for measuring interest rates are the same for the hedging instrument and the hedged item.
148. On the other hand, sometimes the hedging instrument will offset the hedged risk only partially. For instance, a hedge would not be fully effective if the hedging instrument and hedged item are denominated in different currencies and the two do not move in tandem. Also, a hedge of interest rate risk using a derivative would not be fully effective if part of the change in the fair value of the derivative is due to the counterparty's credit risk.
149. To qualify for special hedge accounting, the hedge must relate to a specific identified and designated risk, and not merely to overall enterprise business risks, and must ultimately affect the enterprise's net profit or loss. A hedge of the risk of obsolescence of a physical asset or the risk of expropriation of property by a government would not be eligible for hedge accounting; effectiveness cannot be measured since those risks are not measurable reliably.
150. An equity method investment cannot be a hedged item in a fair value hedge because the equity method recognizes the investor's share of the associate's accrued net profit or loss, rather than fair value changes, in net profit or loss. If it were a hedged item, it would be adjusted for both fair value changes and profit and loss accruals - which would result in double counting because the fair value changes include the profit and loss accruals. For a similar reason, an investment in a consolidated subsidiary cannot be a hedged item in a fair value hedge because consolidation recognizes the parent's share of the subsidiary's accrued net profit or loss, rather than fair value changes, in net profit or loss. A hedge of a net investment in a foreign subsidiary is different. There is no double counting because it is a hedge of the foreign currency exposure, not a fair value hedge of the change in the value of the investment.
151. This Standard does not specify a single method for assessing hedge effectiveness.
An enterprise's documentation of its hedging strategy will include its procedures for
assessing effectiveness. Those procedures will state whether the assessment will include
all of the gain or loss on a hedging instrument or whether the instrument's time value
will be excluded. Effectiveness is assessed, at a minimum, at the time an enterprise
prepares its annual or interim financial report. If the critical terms of the hedging
instrument and the entire hedged asset or liability (as opposed to selected cash flows) or
hedged forecasted transaction are the same, an enterprise could conclude that changes in
fair value or cash flows attributable to the risk being hedged are expected to completely
offset at inception and on an ongoing basis. For example, an entity may assume that a
hedge of a forecasted purchase of a commodity with a forward contract will be highly
effective and that there will be no ineffectiveness to be recognized in net profit or loss
if:
(a) the forward contract is for purchase of the same quantity of the same commodity at the
same time and location as the hedged forecasted purchase;
(b) the fair value of the forward contract at inception is zero; and
(c) either the change in the discount or premium on the forward contract is excluded from
the assessment of effectiveness and included directly in net profit or loss or the change
in expected cash flows on the forecasted transaction is based on the forward price for the
commodity.
152. In assessing the effectiveness of a hedge, an enterprise will generally need to consider the time value of money. The fixed rate on a hedged item need not exactly match the fixed rate on a swap designated as a fair value hedge. Nor does the variable rate on an interest-bearing asset or liability need to be the same as the variable rate on a swap designated as a cash flow hedge. A swap's fair value comes from its net settlements. The fixed and variable rates on a swap can be changed without affecting the net settlement if both are changed by the same amount.
153. If a fair value hedge meets the conditions in paragraph 142 during the
financial reporting period, it should be accounted for as follows:
(a) the gain or loss from remeasuring the hedging instrument at fair value should be
recognized immediately in net profit or loss; and
(b) the gain or loss on the hedged item attributable to the hedged risk should adjust the
carrying amount of the hedged item and be recognized immediately in net profit or loss.
This applies even if a hedged item is otherwise measured at fair value with changes in
fair value recognized directly in equity under paragraph 103(b). It also applies if the
hedged item is otherwise measured at cost.
154. The following illustrates how paragraph 153 applies to a hedge of exposure to
changes in the fair value of an investment in fixed rate debt as a result of changes in
interest rates. This example is presented from the perspective of the holder. In Year 1 an
investor purchases for 100 a debt security that is classified as available for sale. At
the end of Year 1, current fair value is 110. Therefore, the 10 increase is reported in
equity (assuming the investor has elected this method), and the carrying amount is
increased to 110 in the balance sheet. To protect the 110 value, the holder enters into a
hedge by acquiring a derivative. By the end of Year 2, the derivative has a gain of 5, and
the debt security has a corresponding decline in fair value.
Investor's Books Year 1: Debit Credit
Investment in debt security 100
Cash 100
To reflect the purchase of the security.
Investment in debt security 10
Increase in fair value (included 10
in equity)
To reflect the increase in fair value of the security.
Investor's Books Year 2: Debit Credit
Derivative asset 5
Gain (included in net profit or loss) 5
To reflect the increase in fair value of the derivative.
Loss (included in net profit or loss) 5
Investment in debt security 5
To reflect the decrease in fair value of the debt security.
The carrying amount of the debt security is 105 at the end of Year 2, and the carrying
amount of the derivative is 5. The gain of 10 is reported in equity until the debt
security is sold, and it is subject to amortization in accordance with paragraph
157.
155. If only certain risks attributable to a hedged item have been hedged, recognized changes in the fair value of the hedged item unrelated to the hedge are reported in one of the two ways set out in paragraph 103.
156. An enterprise should discontinue prospectively the hedge accounting
specified in paragraph 153 if any one of the following occurs:
(a) the hedging instrument expires or is sold, terminated, or exercised (for this purpose,
the replacement or a rollover of a hedging instrument into another hedging instrument is
not considered an expiration or termination if such replacement or rollover is part of the
enterprise's documented hedging strategy); or
(b) the hedge no longer meets the criteria for qualification for hedge accounting in
paragraph 142.
157. An adjustment to the carrying amount of a hedged interest-bearing financial instrument should be amortized to net profit or loss. Amortization should begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged. The adjustment should be fully amortized by maturity.
158. If a cash flow hedge meets the conditions in paragraph 142 during the
financial reporting period, it should be accounted for as follows:
(a) the portion of the gain or loss on the hedging instrument that is determined to be an
effective hedge (see paragraph 142) should be recognized directly in equity through the
statement of changes in equity (see IAS 1, paragraphs 86-88); and
(b) the ineffective portion should be reported:
(i) immediately in net profit or loss if the hedging instrument is a derivative; or
(ii) in accordance with paragraph 103 in the limited circumstances in which the hedging
instrument is not a derivative.
159. More specifically, a cash flow hedge is accounted for as follows:
(a) the separate component of equity associated with the hedged item is adjusted to the
lesser of the following (in absolute amounts):
(i) the cumulative gain or loss on the hedging instrument necessary to offset the
cumulative change in expected future cash flows on the hedged item from inception of the
hedge excluding the ineffective component discussed in paragraph 158(b); and
(ii) the fair value of the cumulative change in expected future cash flows on the hedged
item from inception of the hedge;
(b) any remaining gain or loss on the hedging instrument (which is not an effective hedge)
is included in net profit or loss or directly in equity as appropriate under paragraphs
103 and 158; and
(c) if an enterprise's documented risk management strategy for a particular hedging
relationship excludes a specific component of the gain or loss or related cash flows on
the hedging instrument from the assessment of hedge effectiveness (see paragraph 142(a)),
that excluded component of gain or loss is recognized in accordance with paragraph
103.
160. If the hedged firm commitment or forecasted transaction results in the recognition of an asset or a liability, then at the time the asset or liability is recognized the associated gains or losses that were recognized directly in equity in accordance with paragraph 158 should be removed from equity and should enter into the initial measurement of the acquisition cost or other carrying amount of the asset or liability.
161. The gain or loss on the hedging instrument that was included in the initial measurement of the acquisition cost or other carrying amount of the asset or liability is subsequently included in net profit or loss when the asset or liability affects net profit or loss (such as in the periods that depreciation expense, interest income or expense, or cost of sales is recognized). The provisions of other International Accounting Standards with respect to impairment of assets (see IAS 36, Impairment of Assets) and net realizable values of inventories (see IAS 2, Inventories) apply to assets arising from hedges of forecasted transactions.
162. For all cash flow hedges other than those covered by paragraph 160, amounts that had been recognized directly in equity should be included in net profit or loss in the same period or periods during which the hedged firm commitment or forecasted transaction affects net profit or loss (for example, when a forecasted sale actually occurs).
163. An enterprise should discontinue prospectively the hedge accounting
specified in paragraphs 158-162 if any one of the following occurs:
(a) the hedging instrument expires or is sold, terminated, or exercised (for this purpose,
the replacement or a rollover of a hedging instrument into another hedging instrument is
not considered an expiration or termination if such replacement or rollover is part of the
enterprise's documented hedging strategy). In this case, the cumulative gain or loss on
the hedging instrument that initially had been reported directly in equity when the hedge
was effective (see paragraph 158(a)) should remain separately in equity until the
forecasted transaction occurs. When the transaction occurs, paragraphs 160 and 162 apply;
(b) the hedge no longer meets the criteria for qualification for hedge accounting in
paragraph 142. In this case, the cumulative gain or loss on the hedging instrument that
initially had been reported directly in equity when the hedge was effective (see paragraph
158(a)) should remain separately in equity until the committed or forecasted transaction
occurs. When the transaction occurs, paragraphs 161 and 162 apply; or
(c) the committed or forecasted transaction is no longer expected to occur, in which case
any related net cumulative gain or loss that has been reported directly in equity should
be reported in net profit or loss for the period.
Hedges of a Net Investment in a Foreign Entity
164. Hedges of a net investment in a foreign entity (see IAS 21, The Effects of
Changes in Foreign Exchange Rates) should be accounted for similarly to cash flow hedges:
(a) the portion of the gain or loss on the hedging instrument that is determined to be an
effective hedge (see paragraph 142) should be recognized directly in equity through the
statement of changes in equity (see IAS 1, paragraphs 86-88); and
(b) the ineffective portion should be reported:
(i) immediately in net profit or loss if the hedging instrument is a derivative; or
(ii) in accordance with paragraph 19 of IAS 21, in the limited circumstances in which the
hedging instrument is not a derivative.
The gain or loss on the hedging instrument relating to the effective portion of the hedge
should be classified in the same manner as the foreign currency translation gain or
loss.
If a Hedge Does Not Qualify for Special Hedge Accounting
165. If a hedge does not qualify for special hedge accounting because it fails to meet the criteria in paragraph 142, gains and losses arising from changes in the fair value of a hedged item that is measured at fair value subsequent to initial recognition are reported in one of the two ways set out in paragraph 103. Fair value adjustments of a hedging instrument that is a derivative would be reported in net profit or loss.
166. Financial statements should include all of the disclosures required by IAS 32, except that the requirements in IAS 32 for supplementary disclosure of fair values (paragraphs 77 and 88) are not applicable to those financial assets and financial liabilities carried at fair value.
167. The following should be included in the disclosures of the enterprise's
accounting policies as part of the disclosure required by IAS 32 paragraph 47(b):
(a) the methods and significant assumptions applied in estimating fair values of financial
assets and financial liabilities that are carried at fair value, separately for
significant classes of financial assets (paragraph 46 of IAS 32 provides guidance for
determining classes of financial assets);
(b) whether gains and losses arising from changes in the fair value of those
available-for-sale financial assets that are measured at fair value subsequent to initial
recognition are included in net profit or loss for the period or are recognized directly
in equity until the financial asset is disposed of; and
(c) for each of the four categories of financial assets defined in paragraph 10, whether
'regular way' purchases of financial assets are accounted for at trade date or settlement
date (see paragraph 30).
168. In applying paragraph 167(a), an enterprise will disclose prepayment rates, rates of estimated credit losses, and interest or discount rates.
169. Financial statements should include all of the following additional
disclosures relating to hedging:
(a) describe the enterprise's financial risk management objectives and policies, including
its policy for hedging each major type of forecasted transaction (see paragraph 142(a));
For example, in the case of hedges of risks relating to future sales, that description
indicates the nature of the risks being hedged, approximately how many months or years of
expected future sales have been hedged, and the approximate percentage of sales in those
future months or years;
(b) disclose the following separately for designated fair value hedges, cash flow hedges,
and hedges of a net investment in a foreign entity:
(i) a description of the hedge;
(ii) a description of the financial instruments designated as hedging instruments for the
hedge and their fair values at the balance sheet date;
(iii) the nature of the risks being hedged; and
(iv) for hedges of forecasted transactions, the periods in which the forecasted
transactions are expected to occur, when they are expected to enter into the determination
of net profit or loss, and a description of any forecasted transaction for which hedge
accounting had previously been used but that is no longer expected to occur; and
(c) if a gain or loss on derivative and non-derivative financial assets and liabilities
designated as hedging instruments in cash flow hedges has been recognized directly in
equity, through the statement of changes in equity, disclose:
(i) the amount that was so recognized in equity during the current period;
(ii) the amount that was removed from equity and reported in net profit or loss for the
period; and
(iii) the amount that was removed from equity and added to the initial measurement of the
acquisition cost or other carrying amount of the asset or liability in a hedged forecasted
transaction during the current period (see paragraph 160).
170. Financial statements should include all of the following additional
disclosures relating to financial instruments:
(a) if a gain or loss from remeasuring available-for-sale financial assets to fair value
(other than assets relating to hedges) has been recognized directly in equity, through the
statement of changes in equity, disclose:
(i) the amount that was so recognized in equity during the current period; and
(ii) the amount that was removed from equity and reported in net profit or loss for the
period;
(b) if the presumption that fair value can be reliably measured for all financial assets
that are available for sale or held for trading has been overcome (see paragraph 70) and
the enterprise is, therefore, measuring any such financial assets at amortized cost,
disclose that fact together with a description of the financial assets, their carrying
amount, an explanation of why fair value cannot be reliably measured, and, if possible,
the range of estimates within which fair value is highly likely to lie. Further, if
financial assets whose fair value previously could not be measured reliably are sold, that
fact, the carrying amount of such financial assets at the time of sale, and the amount of
gain or loss recognized should be disclosed;
(c) disclose significant items of income, expense, and gains and losses resulting from
financial assets and financial liabilities, whether included in net profit or loss or as a
separate component of equity. For this purpose:
(i) total interest income and total interest expense (both on a historical cost basis)
should be disclosed separately;
(ii) with respect to available-for-sale financial assets that are adjusted to fair value
after initial acquisition, total gains and losses from derecognition of such financial
assets included in net profit or loss for the period should be reported separately from
total gains and losses from fair value adjustments of recognized assets and liabilities
included in net profit or loss for the period (a similar split of 'realized' versus
'unrealized' gains and losses with respect to financial assets and liabilities held for
trading is not required);
(iii) the enterprise should disclose the amount of interest income that has been accrued
on impaired loans pursuant to paragraph 116 and that has not yet been received in
cash;
(d) if the enterprise has entered into a securitization or repurchase agreement, disclose,
separately for such transactions occurring in the current financial reporting period and
for remaining retained interests from transactions occurring in prior financial reporting
periods:
(i) the nature and extent of such transactions, including a description of any collateral
and quantitative information about the key assumptions used in calculating the fair values
of new and retained interests;
(ii) whether the financial assets have been derecognized;
(e) if the enterprise has reclassified a financial asset as one required to be reported at
amortized cost rather than at fair value (see paragraph 92), disclose the reason for that
reclassification; and
(f) disclose the nature and amount of any impairment loss or reversal of an impairment
loss recognized for a financial asset, separately for each significant class of financial
asset (paragraph 46 of IAS 32 provides guidance for determining classes of financial
assets).
Effective Date and Transition
171. This International Accounting Standard becomes operative for financial statements covering financial years beginning on or after 1 January 2001. Earlier application is permitted only as of the beginning of a financial year that ends after 15 March 1999 (the date of issuance of this Standard). Retrospective application is not permitted.
172. The transition to this Standard should be as follows:
(a) recognition, derecognition, measurement, and hedge accounting policies followed in
financial statements for periods prior to the effective date of this Standard should not
be reversed and, therefore, those financial statements should not be restated;
(b) for those transactions entered into before the beginning of the financial year in
which this Standard is initially applied that the enterprise did previously designate as
hedges, the recognition, derecognition, and measurement provisions of this Standard should
be applied prospectively. Therefore, if the previously designated hedge does not meet the
conditions for an effective hedge set out in paragraph 142 and the hedging instrument is
still held, hedge accounting will no longer be appropriate starting with the beginning of
the financial year in which this Standard is initially applied. Accounting in prior
financial years should not be retrospectively changed to conform to the requirements of
this Standard. Paragraphs 156 and 163 explain how to discontinue hedge accounting;
(c) at the beginning of the financial year in which this Standard is initially applied, an
enterprise should recognize all derivatives in its balance sheet as either assets or
liabilities and should measure them at fair value (except for a derivative that is linked
to and that must be settled by delivery of an unquoted equity instrument whose fair value
cannot be measured reliably). Because all derivatives, other than those that are
designated hedging instruments, are considered held for trading, the difference between
previous carrying amount (which may have been zero) and fair value of derivatives should
be recognized as an adjustment of the balance of retained earnings at the beginning of the
financial year in which this Standard is initially applied (other than for a derivative
that is a designated hedging instrument);
(d) at the beginning of the financial year in which this Standard is initially applied, an
enterprise should apply the criteria in paragraphs 66-102 to identify those financial
assets and liabilities that should be measured at fair value and those that should be
measured at amortized cost, and it should remeasure those assets as appropriate. Any
adjustment of the previous carrying amount should be recognized as an adjustment of the
balance of retained earnings at the beginning of the financial year in which this Standard
is initially applied;
(e) at the beginning of the financial year in which this Standard is initially applied,
any balance sheet positions in fair value hedges of existing assets and liabilities should
be accounted for by adjusting their carrying amounts to reflect the fair value of the
hedging instrument;
(f) if an enterprise's hedge accounting policies prior to initial application of this
Standard had included deferral, as assets and liabilities, of gains or losses on cash flow
hedges, at the beginning of the financial year in which this Standard is initially
applied, those deferred gains and losses should be reclassified as a separate component of
equity to the extent that the transactions meet the criteria in paragraph 142 and,
thereafter, accounted for as set out in paragraphs 160-162;
(g) transactions entered into before the beginning of the financial year in which this
Standard is initially applied should not be retrospectively designated as hedges;
(h) if a securitization, transfer, or other derecognition transaction was entered into
prior to the beginning of the financial year in which this Standard is initially applied,
the accounting for that transaction should not be retrospectively changed to conform to
the requirements of this Standard; and
(i) at the beginning of the financial year in which this Standard is initially applied, an
enterprise should classify a financial instrument as equity or as a liability in
accordance with paragraph 11 of this Standard.
This Standard amends existing International Accounting Standards as follows:
This Standard adds the following words to the end of the last sentence of paragraph 11
of IAS 18, Revenue:
and in accordance with IAS 39, Financial Instruments: Recognition and Measurement.
In the Bound Volume of International Accounting Standards 1998, several paragraphs of
guidance relating to hedge accounting had been included immediately before the beginning
of IAS 21, The Effects of Changes in Foreign Exchange Rates. That guidance was in the
original IAS 21 but was deleted when IAS 21 was revised in 1993 in the expectation that a
new Standard addressing hedge accounting would be issued in 1994. Because IAS 39 covers
hedge accounting, the guidance from the original IAS 21 will not be included in future
editions of the Bound Volume.
This Standard amends the last sentence of paragraph 2 of IAS 21 to read as follows:
Other aspects of hedge accounting, including the criteria to use hedge accounting, are
dealt with in IAS 39, Financial Instruments: Recognition and Measurement.
This Standard amends the last sentence of paragraph 14 of IAS 21 to read as follows:
Other aspects of hedge accounting, including the criteria to use hedge accounting, are
dealt with in IAS 39, Financial Instruments: Recognition and Measurement.
This Standard supersedes those portions of IAS 25, Accounting for Investments, that
address accounting for investments in debt and equity securities and other financial
instruments. The remaining portion of IAS 25, which addresses accounting for investments
in land and buildings and other tangible and intangible assets acquired for investment
purposes rather than for use, is currently under review. Paragraph 3 of IAS 25 lists the
types of investments excluded from the scope of IAS 25, and the following subparagraph is
added to that list:
(h) investments in financial assets to which IAS 39, Financial Instruments: Recognition
and Measurement, applies.
This Standard amends the last sentence of paragraph 13 of IAS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries, to read as follows:
Such subsidiaries should be accounted for as if they are investments in accordance with IAS 39, Financial Instruments: Recognition and Measurement.
This Standard amends the first sentence of paragraph 24 of IAS 27 to change the reference from 'IAS 25, Accounting for Investments', to 'IAS 39, Financial Instruments: Recognition and Measurement'.
This Standard amends paragraph 29 of IAS 27 to read as follows:
29. In a parent's separate financial statements, investments in subsidiaries
that are included in the consolidated financial statements should be either:
(a) carried at cost;
(b) accounted for using the equity method as described in IAS 28, Accounting for
Investments in Associates; or
(c) accounted for as available-for-sale financial assets as described in IAS 39, Financial
Instruments: Recognition and Measurement.
This Standard amends paragraph 30 of IAS 27 to read as follows:
30. In a parent's separate financial statements, investments in subsidiaries
that are excluded from consolidated financial statements should be either:
(a) carried at cost;
(b) accounted for using the equity method as described in IAS 28, Accounting for
Investments in Associates; or
(c) accounted for as available-for-sale financial assets as described in IAS 39, Financial
Instruments: Recognition and Measurement.
The words 'in accordance with IAS 25, Accounting for Investments' are deleted from the end of paragraph 7 of IAS 28.
This Standard amends paragraph 12 of IAS 28 to read as follows:
12. An investment in an associate that is included in the separate financial
statements of an investor that issues consolidated financial statements and that is not
held exclusively with a view to its disposal in the near future should be either:
(a) carried at cost;
(b) accounted for using the equity method as described in this Standard; or
(c) accounted for as an available-for-sale financial asset as described in IAS 39,
Financial Instruments: Recognition and Measurement.
This Standard amends paragraph 14 of IAS 28 to read as follows:
14. An investment in an associate that is included in the financial statements
of an investor that does not issue consolidated financial statements should be either:
(a) carried at cost;
(b) accounted for using the equity method as described in this Standard if the equity
method would be appropriate for the associate if the investor had issued consolidated
financial statements; or
(c) accounted for under IAS 39, Financial Instruments: Recognition and Measurement, as an
available-for-sale financial asset or a financial asset held for trading based on the
definitions in IAS 39.
This Standard amends paragraphs 24 and 25 of IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, as follows:
24. A bank should disclose the fair values of each class of its financial assets and liabilities as required by IAS 32, Financial Instruments: Disclosure and Presentation, and IAS 39, Financial Instruments: Recognition and Measurement.
25. IAS 39 provides for four classifications of financial assets: loans and receivables originated by the enterprise, held-to-maturity investments, financial assets held for trading, and available-for-sale financial assets. A bank will disclose the fair values of its financial assets for these four classifications, as a minimum.
This Standard amends the first sentence of paragraph 35 of IAS 31 as follows:
35. A venturer should account for the following investments either at cost or in accordance with IAS 39, Financial Instruments: Recognition and Measurement.
This Standard amends paragraph 42 of IAS 31 as follows:
42. An investor in a joint venture, which does not have joint control, should report its interest in a joint venture in its consolidated financial statements in accordance with IAS 39, Financial Instruments: Recognition and Measurement, or, if it has significant influence in the joint venture, in accordance with IAS 28, Accounting for Investments in Associates. In the separate financial statements of an investor that issues consolidated financial statements, it may also report the investment at cost.
This Standard amends IAS 32 to include the following addition to the definition of financial instrument in paragraph 5 of that Standard:
Commodity-based contracts that give either party the right to settle in cash or some other financial instrument should be accounted for as if they were financial instruments, with the exception of commodity contracts that (a) were entered into and continue to meet the enterprise's expected purchase, sale, or usage requirements, (b) were designated for that purpose at their inception, and (c) are expected to be settled by delivery.
This Standard amends IAS 32 to include the following elaboration on the definition of financial liability in paragraph 5 of that Standard:
An enterprise may have a contractual obligation that it can settle either by payment of financial assets or by payment in the form of its own equity securities. In such a case, if the number of equity securities required to settle the obligation varies with changes in their fair value so that the total fair value of the equity securities paid always equals the amount of the contractual obligation, the holder of the obligation is not exposed to gain or loss from fluctuations in the price of the equity securities. Such an obligation should be accounted for as a financial liability of the enterprise.
The clause ', adjusted for the transaction costs that would be incurred in an actual
transaction,' is deleted from the guidance in paragraph 81 of IAS 32.
The words 'takes into account' in the first sentence of paragraph 83 of IAS 32 are
replaced with the words 'is determined without deduction for'.
This Standard amends IAS 32 to add the following subheading and paragraph between
paragraphs 43 and 44:
Disclosure of Risk Management Policies
43A. An enterprise should describe its financial risk management objectives and
policies, including its policy for hedging each major type of forecasted transaction for
which hedge accounting is used.
The first sentence of paragraph 52 of IAS 32 is deleted. The reference in the second
sentence to 'IAS 1, Disclosure of Accounting Policies', is changed to 'IAS 1, Presentation
of Financial Statements'.
This Standard amends paragraph 2(f) of IAS 38, Intangible Assets, to replace the
reference to IAS 25, Accounting for Investments, by reference to IAS 39, and to delete
footnote 1.
Revised International Accounting Standards
IAS 22 (revised 1998)
Business Combinations
(effective 1 July 1999)
IAS 22, Accounting for Business Combinations, was approved in November 1983.
In December 1993, IAS 22 was revised as part of the project on Comparability and
Improvements of Financial Statements. It became IAS 22, Business Combinations (IAS 22
(revised 1993)).
In October 1996, paragraphs 39(i) and 69 of IAS 22 (i.e. paragraphs 39(i) and 85 of this
Standard), were revised to be consistent with IAS 12 (revised 1996), Income Taxes. The
revisions became operative for annual financial statements covering periods beginning on
or after 1 January 1998.
In July 1998, various paragraphs of IAS 22 were revised to be consistent with IAS 36,
Impairment of Assets, IAS 37, Provisions, Contingent Liabilities and Contingent Assets,
and IAS 38, Intangible Assets, and the treatment of negative goodwill was also revised.
The revised Standard (IAS 22 (revised 1998)) becomes operative for annual financial
statements covering periods beginning on or after 1 July 1999. Earlier application is
encouraged. If an enterprise applies this revised Standard for annual financial statements
covering periods beginning before 1 July 1999, the enterprise should adopt IAS 36, IAS 37
and IAS 38 at the same time.
For the purpose of this publication, the new text is shaded and the text deleted from IAS
22 (revised 1993) is shaded and struck through.
In October 1998, the IASC staff published separately a Basis for Conclusions for IAS 38,
Intangible Assets and IAS 22 (revised 1998). Copies are available from IASC's Publications
Department.*
One SIC Interpretation relates to IAS 22:
· SIC-9, Business Combinations – Classification either as Acquisitions or Unitings
of Interest.
International Accounting Standard IAS 22
Business Combinations (revised 1998 1993)
The standards, which have been set in bold italic type, should be read in the context of
the background material and implementation guidance in this Standard, and in the context
of the Preface to International Accounting Standards. International Accounting Standards
are not intended to apply to immaterial items (see paragraph 12 of the Preface).
Objective
The objective of this Standard is to prescribe the accounting treatment for business combinations. The Standard covers both an acquisition of one enterprise by another and also the rare situation of a uniting of interests when an acquirer cannot be identified. Accounting for an acquisition involves determination of the cost of the acquisition, allocation of the cost over the identifiable assets and liabilities of the enterprise being acquired and accounting for the resulting goodwill or negative goodwill, both at acquisition and subsequently. Other accounting issues include the determination of the minority interest amount, accounting for acquisitions which occur over a period of time, subsequent changes in the cost of acquisition or in the identification of assets and liabilities, and the disclosures required.
Scope
1. This Standard should be applied in accounting for business combinations.
2. This Standard supersedes International Accounting Standard IAS 22, Accounting for Business Combinations, approved in 1983.
2 3. A business combination may be structured in a variety of ways which are determined for legal, taxation or other reasons. It may involve the purchase by an enterprise of the equity of another enterprise or the purchase of the net assets of a business enterprise. It may be effected by the issue of shares or by the transfer of cash, cash equivalents or other assets. The transaction may be between the shareholders of the combining enterprises or between one enterprise and the shareholders of the other enterprise. The business combination may involve the establishment of a new enterprise to have control over the combining enterprises, the transfer of the net assets of one or more of the combining enterprises to another enterprise or the dissolution of one or more of the combining enterprises. When the substance of the transaction is consistent with the definition of a business combination in this Standard, the accounting and disclosure requirements contained in this Standard are appropriate irrespective of the particular structure adopted for the combination.
3 4. A business combination may result in a parent-subsidiary relationship in which the acquirer is the parent and the acquiree a subsidiary of the acquirer. In such circumstances, the acquirer applies this Standard in its consolidated financial statements. It includes its interest in the acquiree in its separate financial statements as an investment in a subsidiary (see IAS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries).
4 5. A business combination may involve the purchase of the net assets, including any goodwill, of another enterprise rather than the purchase of the shares in the other enterprise. Such a business combination does not result in a parent-subsidiary relationship. In such circumstances, the acquirer applies this Standard in its separate financial statements and consequently in its consolidated financial statements.
5 6. A business combination may give rise to a legal merger. While the requirements for
legal mergers differ among countries, a legal merger is usually a merger between two
companies in which either:
(a) the assets and liabilities of one company are transferred to the other company and the
first company is dissolved; or
(b) the assets and liabilities of both companies are transferred to a new company and both
the original companies are dissolved.
Many legal mergers arise as part of the restructuring or reorganization of a group and are
not dealt with in this Standard because they are transactions among enterprises under
common control. However, any business combination that resulted in the two companies
becoming members of the same group is dealt with as an acquisition or as a uniting of
interests in consolidated financial statements under in accordance with the requirements
of this Standard.
6 7. This Standard does not deal with the separate financial statements of a parent other than in the circumstances described in paragraph 4 5. Separate financial statements are prepared using different reporting practices in different countries in order to meet a variety of needs.
7 8. This Standard does not deal with:
(a) transactions among enterprises under common control; and
(b) interests in joint ventures (see IAS 31, Financial Reporting of Interests in Joint
Ventures) and the financial statements of joint ventures.
Definitions
8 9. The following terms are used in this Standard with the meanings specified:
A business combination is the bringing together of separate enterprises into one
economic entity as a result of one enterprise uniting with or obtaining control over the
net assets and operations of another enterprise.
An acquisition is a business combination in which one of the enterprises, the acquirer,
obtains control over the net assets and operations of another enterprise, the acquiree, in
exchange for the transfer of assets, incurrence of a liability or issue of equity.
A uniting of interests is a business combination in which the shareholders of the
combining enterprises combine control over the whole, or effectively the whole, of their
net assets and operations to achieve a continuing mutual sharing in the risks and benefits
attaching to the combined entity such that neither party can be identified as the
acquirer.
Control is the power to govern the financial and operating policies of an enterprise so as
to obtain benefits from its activities.
A parent is an enterprise that has one or more subsidiaries.
A subsidiary is an enterprise that is controlled by another enterprise (known as the
parent).
Minority interest is that part of the net results of operations and of net assets of a
subsidiary attributable to interests which are not owned, directly or indirectly through
subsidiaries, by the parent.
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.
Monetary assets are money held and assets to be received in fixed or determinable amounts
of money.
Date of acquisition is the date on which control of the net assets and operations of the
acquiree is effectively transferred to the acquirer.
Nature of a Business Combination
9 10. In accounting for a business combination, an acquisition is in substance different from a uniting of interests and the substance of the transaction needs to be reflected in the financial statements.1 Accordingly, a different accounting method is prescribed for each.
Acquisitions
10 11. In virtually all business combinations one of the combining enterprises obtains
control over the other combining enterprise, thereby enabling an acquirer to be
identified. Control is presumed to be obtained when one of the combining enterprises
acquires more than one half of the voting rights of the other combining enterprise unless,
in exceptional circumstances, it can be clearly demonstrated that such ownership does not
constitute control. Even when one of the combining enterprises does not acquire more than
one half of the voting rights of the other combining enterprise, it may still be possible
to identify an acquirer when one of the combining enterprises, as a result of the business
combination, acquires:
(a) power over more than one half of the voting rights of the other enterprise by virtue
of an agreement with other investors;
(b) power to govern the financial and operating policies of the other enterprise under a
statute or an agreement;
(c) power to appoint or remove the majority of the members of the board of directors or
equivalent governing body of the other enterprise; or
(d) power to cast the majority of votes at meetings of the board of directors or
equivalent governing body of the other enterprise.
11 12. Although it may sometimes be difficult to identify an acquirer, there are
usually indications that one exists. For example:
(a) the fair value of one enterprise is significantly greater than that of the other
combining enterprise. In such cases, the larger enterprise is the acquirer;
(b) the business combination is effected through an exchange of voting common shares for
cash. In such cases, the enterprise giving up cash is the acquirer; or
(c) the business combination results in the management of one enterprise being able to
dominate the selection of the management team of the resulting combined enterprise. In
such cases the dominant enterprise is the acquirer.
Reverse Acquisitions
12 13. Occasionally an enterprise obtains ownership of the shares of another enterprise
but as part of the exchange transaction issues enough voting shares, as consideration,
such that control of the combined enterprise passes to the owners of the enterprise whose
shares have been acquired. This situation is described as a reverse acquisition. Although
legally the enterprise issuing the shares may be regarded as the parent or continuing
enterprise, the enterprise whose shareholders now control the combined enterprise is the
acquirer enjoying the voting or other powers identified in paragraph 10 11. The enterprise
issuing the shares is deemed to have been acquired by the other enterprise; the latter
enterprise is deemed to be the acquirer and applies the purchase method to the assets and
liabilities of the enterprise issuing the shares.
Unitings of Interests
13 14. In exceptional circumstances, it may not be possible to identify an acquirer. Instead of a dominant party emerging, the shareholders of the combining enterprises join in a substantially equal arrangement to share control over the whole, or effectively the whole, of their net assets and operations. In addition, the management's of the combining enterprises participate in the management of the combined entity. As a result, the shareholders of the combining enterprises share mutually in the risks and benefits of the combined entity. Such a business combination is accounted for as a uniting of interests.
14 15. A mutual sharing of risks and benefits is usually not possible without a substantially equal exchange of voting common shares between the combining enterprises. Such an exchange ensures that the relative ownership interests of the combining enterprises, and consequently their relative risks and benefits in the combined enterprise, are maintained and the decision-making powers of the parties are preserved. However, for a substantially equal share exchange to be effective in this regard there cannot be a significant reduction in the rights attaching to the shares of one of the combining enterprises, otherwise the influence of that party is weakened.
15 16. In order to achieve a mutual sharing of the risks and benefits of the combined
entity:
(a) the substantial majority, if not all, of the voting common shares of the combining
enterprises are exchanged or pooled;
(b) the fair value of one enterprise is not significantly different from that of the other
enterprise; and
(c) the shareholders of each enterprise maintain substantially the same voting rights and
interest in the combined entity, relative to each other, after the combination as before.
16 17. The mutual sharing of the risks and benefits of the combined entity diminishes
and the likelihood that an acquirer can be identified increases when:
(a) the relative equality in fair values of the combining enterprises is reduced and the
percentage of voting common shares exchanged decreases;
(b) financial arrangements provide a relative advantage to one group of shareholders over
the other shareholders. Such arrangements may take effect either prior to or after the
business combination; and
(c) one party's share of the equity in the combined entity depends on how the business
which it previously controlled performs subsequent to the business combination.
Acquisitions
Accounting for Acquisitions
17 18. A business combination which is an acquisition should be accounted for by use of the purchase method of accounting as set out in the standards contained in paragraphs 19 20 to 76 60.
18 19. The use of the purchase method results in an acquisition of an enterprise being accounted for similarly to the purchase of other assets. This is appropriate since an acquisition involves a transaction in which assets are transferred, liabilities are incurred or capital is issued in exchange for control of the net assets and operations of another enterprise. The purchase method uses cost as the basis for recording the acquisition and relies on the exchange transaction underlying the acquisition for determination of the cost.
Date of Acquisition
19 20. As from the date of acquisition, an acquirer should:
(a) incorporate into the income statement the results of operations of the acquiree; and
(b) recognize in the balance sheet the identifiable assets and liabilities of the acquiree
and any goodwill or negative goodwill arising on the acquisition.
20 21. The date of acquisition is the date on which control of the net assets and operations of the acquiree is effectively transferred to the acquirer and the date when application of the purchase method commences. The results of operations of an acquired business are included in the financial statements of the acquirer as from the date of acquisition, which is the date on which control of the acquiree is effectively transferred to the acquirer. In substance, the date of acquisition is the date from when the acquirer has the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. Control is not deemed to have been transferred to the acquirer until all conditions necessary to protect the interests of the parties involved have been satisfied. However, this does not necessitate a transaction being closed or finalized at law before control effectively passes to the acquirer. In assessing whether control has effectively been transferred, the substance of the acquisition needs to be considered.
Cost of Acquisition
21 22. An acquisition should be accounted for at its cost, being the amount of cash or cash equivalents paid or the fair value, at the date of exchange, of the other purchase consideration given by the acquirer in exchange for control over the net assets of the other enterprise, plus any costs directly attributable to the acquisition.
22 23. When an acquisition involves more than one exchange transaction the cost of the acquisition is the aggregate cost of the individual transactions. When an acquisition is achieved in stages, the distinction between the date of acquisition and the date of the exchange transaction is important. While accounting for the acquisition commences as from the date of acquisition, it uses cost and fair value information determined as at the date of each exchange transaction.
23 24. Monetary assets given and liabilities incurred are measured at their fair values at the date of the exchange transaction. When settlement of the purchase consideration is deferred, the cost of the acquisition is the present value of the consideration, taking into account any premium or discount likely to be incurred in settlement, and not the nominal value of the payable.
24 25. In determining the cost of the acquisition, marketable securities issued by the acquirer are measured at their fair value which is their market price as at the date of the exchange transaction, provided that undue fluctuations or the narrowness of the market do not make the market price an unreliable indicator. When the market price on one particular date is not a reliable indicator, price movements for a reasonable period before and after the announcement of the terms of the acquisition need to be considered. When the market is unreliable or no quotation exists, the fair value of the securities issued by the acquirer is estimated by reference to their proportional interest in the fair value of the acquirer's enterprise or by reference to the proportional interest in the fair value of the enterprise acquired, whichever is the more clearly evident. Purchase consideration which is paid in cash to shareholders of the acquiree as an alternative to securities may also provide evidence of the total fair value given. All aspects of the acquisition, including significant factors influencing the negotiations, need to be considered, and independent valuations may be used as an aid in determining the fair value of securities issued.
25 26. In addition to the purchase consideration, the acquirer may incur direct costs relating to the acquisition. These include the costs of registering and issuing equity securities, and professional fees paid to accountants, legal advisers, valuers and other consultants to effect the acquisition. General administrative costs, including the costs of maintaining an acquisitions department, and other costs which cannot be directly attributed to the particular acquisition being accounted for, are not included in the cost of the acquisition but are recognized as an expense as incurred.
Recognition of Identifiable Assets and Liabilities
26 27. Individual The identifiable assets and liabilities acquired that are recognized
under paragraph 19 should be those of the acquiree that existed at the date of acquisition
together with any liabilities recognized under paragraph 31. They should be recognized
separately as at the date of acquisition if when, and only if:
(a) it is probable that any associated future economic benefits will flow to, or resources
embodying economic benefits will flow from, the acquirer; and
(b) a reliable measure is available of their cost or fair value to the acquirer.
27 28. Assets and liabilities that are recognized under acquired which meet the recognition criteria in paragraph 26 27 are described in this Standard as identifiable assets and liabilities. To the extent that assets and liabilities are purchased which do not satisfy these recognition criteria there is a resultant impact on the amount of goodwill or negative goodwill arising on the acquisition, because goodwill or negative goodwill is determined as the residual cost of acquisition after recognizing the identifiable assets and liabilities.
28 29. The identifiable assets and liabilities over which the acquirer obtains control may include assets and liabilities which were not previously recognized in the financial statements of the acquiree. This may be because they did not qualify for recognition prior to the acquisition. This is the case, for example, when a tax benefit arising from tax losses of the acquiree qualifies for recognition as an identifiable asset as a result of the acquirer earning sufficient taxable income.
29. Subject to paragraph 31, liabilities should not be recognized at the date of acquisition if they result from the acquirer's intentions or actions. Liabilities should also not be recognized for future losses or other costs expected to be incurred as a result of the acquisition, whether they relate to the acquirer or the acquiree.
30. The liabilities referred to in paragraph 29 are not liabilities of the acquiree at the date of acquisition. Therefore, they are not relevant in allocating the cost of acquisition. Nonetheless, this Standard contains one specific exception to this general principle. This exception applies if the acquirer has developed plans that relate to the acquiree's business and an obligation comes into existence as a direct consequence of the acquisition. Because these plans are an integral part of the acquirer's plan for the acquisition, this Standard requires an enterprise to recognize a provision for the resulting costs (see paragraph 31). For the purpose of this Standard, identifiable assets and liabilities acquired include the provisions recognized under paragraph 31. Paragraph 31 lays down strict conditions designed to ensure that the plans were an integral part of the acquisition and that within a short time - the earlier of three months after the date of acquisition and the date when the financial statements are approved - the acquirer has developed the plans in a way that requires the enterprise to recognize a restructuring provision under IAS 37, Provisions, Contingent Liabilities and Contingent Assets. This Standard also requires an enterprise to reverse such provisions if the plan is not implemented in the manner expected or within the time originally expected (see paragraph 75) and to disclose information on such provisions (see paragraph 92).
31. At the date of acquisition, the acquirer should recognize a provision that was not
a liability of the acquiree at that date if, and only if, the acquirer has:
(a) at, or before, the date of acquisition, developed the main features of a plan that
involves terminating or reducing the activities of the acquiree and that relates to:
(i) compensating employees of the acquiree for termination of their employment;
(ii) closing facilities of the acquiree;
(iii) eliminating product lines of the acquiree; or
(iv) terminating contracts of the acquiree that have become onerous because the acquirer
has communicated to the other party at, or before, the date of acquisition that the
contract will be terminated;
(b) by announcing the main features of the plan at, or before, the date of acquisition,
raised a valid expectation in those affected by the plan that it will implement the plan;
and
(c) by the earlier of three months after the date of acquisition and the date when the
annual financial statements are approved, developed those main features into a detailed
formal plan identifying at least:
(i) the business or part of a business concerned;
(ii) the principal locations affected;
(iii) the location, function, and approximate number of employees who will be compensated
for terminating their services;
(iv) the expenditures that will be undertaken; and
(v) when the plan will be implemented.
Any provision recognized under this paragraph should cover only the costs of the items listed in (a)(i) to (iv) above.
30. Assets and liabilities requiring recognition at the date of acquisition may also include those arising as a result of the acquisition. For instance, the acquirer, in making the acquisition may have undertaken an obligation to compensate employees of the acquiree for services rendered prior to the acquisition. However, application of the recognition criteria does not permit the raising of a provision to cover future operating losses.
Allocation of Cost of Acquisition
Benchmark Treatment
32 31. The identifiable assets and liabilities recognized under in accordance with
paragraph 26 27 should be measured at the aggregate of:
(a) the fair value of the identifiable assets and liabilities acquired as at the date of
the exchange transaction to the extent of the acquirer's interest obtained in the exchange
transaction; and
(b) the minority's proportion of the pre-acquisition carrying amounts of the identifiable
assets and liabilities of the subsidiary.
Any goodwill or negative goodwill should be accounted for under in accordance with this
Standard.
33 32. The cost of an acquisition is allocated to the identifiable assets and liabilities recognized under in accordance with paragraph 26 27 by reference to their fair values at the date of the exchange transaction. However, the cost of the acquisition only relates to the percentage of the identifiable assets and liabilities purchased by the acquirer. Consequently, when an acquirer purchases less than all the shares of the other enterprise, the resulting minority interest is stated at the minority's proportion of the pre-acquisition carrying amounts of the net identifiable assets of the subsidiary. This is because the minority's proportion has not been part of the exchange transaction to effect the acquisition.
Allowed Alternative Treatment
34 33. The identifiable assets and liabilities recognized under in accordance with paragraph 26 27 should be measured at their fair values as at the date of acquisition. Any goodwill or negative goodwill should be accounted for under in accordance with this Standard. Any minority interest should be stated at the minority's proportion of the fair values of the identifiable assets and liabilities recognized under in accordance with paragraph 26 27.
35 34. Under this approach, the net identifiable assets over which the acquirer has
obtained control are stated at their fair values, regardless of whether the acquirer has
acquired all or only some of the capital of the other enterprise or has acquired the
assets directly. Consequently, any minority interest is stated at the minority's
proportion of the fair values of the net identifiable assets of the subsidiary.
Successive Share Purchases
36 35. An acquisition may involve more than one exchange transaction, as for example when it is achieved in stages by successive purchases on a stock exchange. When this occurs, each significant transaction is treated separately for the purpose of determining the fair values of the identifiable assets and liabilities acquired and for determining the amount of any goodwill or negative goodwill on that transaction. This results in a step-by-step comparison of the cost of the individual investments with the acquirer's percentage interest in the fair values of the identifiable assets and liabilities acquired at each significant step.
37 36. When an acquisition is achieved by successive purchases, the fair values of the identifiable assets and liabilities may vary at the date of each exchange transaction. If all the identifiable assets and liabilities relating to an acquisition are restated to fair values at the time of successive purchases, any adjustment relating to the previously held interest of the acquirer is a revaluation and is accounted for as such.
38 37. Prior to qualifying as an acquisition, a transaction may qualify as an investment in an associate and be accounted for by use of the equity method under in accordance with IAS 28, Accounting for Investments in Associates. If so, the determination of fair values for the identifiable assets and liabilities acquired and the recognition of goodwill or negative goodwill occurs notionally as from the date when the equity method is applied. When the investment did not qualify previously as an associate, the fair values of the identifiable assets and liabilities are determined as at the date of each significant step and goodwill or negative goodwill is recognized from the date of acquisition.
Determining the Fair Values of Identifiable Assets and Liabilities Acquired
38. The fair values of identifiable assets and liabilities acquired in an acquisition are determined by reference to their intended use by the acquirer. The intended use of an asset is usually the asset's existing use unless it is probable that the asset will be used for some other purpose. If an asset is intended to be used for another purpose and is valued accordingly, related assets are valued on a consistent basis. When an asset or business segment of the acquiree is to be disposed of, this is taken into consideration in assigning fair values.
39 39. General guidelines for arriving at the fair values of identifiable assets and
liabilities acquired are as follows:
(a) marketable securities at their current market values;
(b) non-marketable securities at estimated values that take into consideration features
such as price earnings ratios, dividend yields and expected growth rates of comparable
securities of enterprises with similar characteristics;
(c) receivables at the present values of the amounts to be received, determined at
appropriate current interest rates, less allowances for uncollectability and collection
costs, if necessary. However, discounting is not required for short-term receivables when
the difference between the nominal amount of the receivable and the discounted amount is
not material;
(d) inventories:
(i) finished goods and merchandise at selling prices less the sum of (a) the costs of
disposal and (b) a reasonable profit allowance for the selling effort of the acquirer
based on profit for similar finished goods and merchandise;
(ii) work in progress at selling prices of finished goods less the sum of (a) costs to
complete, (b) costs of disposal and (c) a reasonable profit allowance for the completing
and selling effort based on profit for similar finished goods; and
(iii) raw materials at current replacement costs;
(e) land and buildings at their market value;:
(i) to be used in their existing use, at their market value for the existing use;
(ii) to be used in a different use, at their market value for the expected use; and
(iii) to be sold or held for later sale, rather than used, at net realizable value;
(f) plant and equipment:
(i) to be used, at their market value, normally determined by appraisal. When there is no
evidence of market value because of the specialized nature of the plant and equipment or
because the items are rarely sold, except as part of a continuing business, they are
valued at their depreciated replacement cost;
(ii) to be used temporarily, at the lower of current replacement cost for similar capacity
and net realizable value; and
(iii) to be sold or held for later sale, rather than used, at net realizable value;
(g) intangible assets, as defined in IAS 38, Intangible Assets, such as patent rights and
licenses, at fair estimated values determined:
(i) by reference to an active market as defined in IAS 38; and
(ii) if no active market exists, on a basis that reflects the amount that the enterprise
would have paid for the asset in an arm's length transaction between knowledgeable willing
parties, based on the best information available (see IAS 38 for further guidance on
determining the fair value of an intangible asset acquired in a business combination);
(h) net employee benefit pension assets or liabilities obligations for defined benefit
plans at the actuarial present value of the defined benefit obligation promised retirement
benefits less the fair value of any plan assets. However, an asset is only recognized to
the extent that it is probable that it will be available to the enterprise in the form of
refunds from the plan or a reduction in future contributions;
(i) tax assets and liabilities, at the amount of the tax benefit arising from tax losses
or the taxes payable in respect of the net profit or loss, assessed from the perspective
of the combined entity or group resulting from the acquisition. The tax asset or liability
is determined after allowing for the tax effect of restating identifiable assets and
liabilities to their fair values and is not discounted. The tax assets include any
deferred tax asset of the acquirer that was not recognized prior to the business
combination, but which, as a consequence of the business combination, now satisfies the
recognition criteria established in IAS 12, Income Taxes;
(j) accounts and notes payable, long-term debt, liabilities, accruals and other claims
payable at the present values of amounts to be disbursed in meeting discharging the
liability determined at appropriate current interest rates. However, discounting is not
required for short-term liabilities when the difference between the nominal amount of the
liability and the discounted amount is not material; and
(k) onerous unfavorable contracts and other identifiable liabilities of the acquiree, and
plant closure expenses incidental to the acquisition, at the present values of amounts to
be disbursed in meeting discharging the obligation determined at appropriate current
interest rates; and
(l) provisions for terminating or reducing activities of the acquiree that are recognized
under paragraph 31, at an amount determined under IAS 37, Provisions, Contingent
Liabilities and Contingent Assets.
Certain of the guidelines above assume that fair values will be determined by the use of
discounting. When the guidelines do not refer to the use of discounting, discounting may
or may not be used in determining the fair values of identifiable assets and liabilities.
40. If the fair value of an intangible asset cannot be measured by reference to an active market (as defined in IAS 38, Intangible Assets), the amount recognized for that intangible asset at the date of the acquisition should be limited to an amount that does not create or increase negative goodwill that arises on the acquisition (see paragraph 59).
Goodwill Arising on Acquisition
Recognition and Measurement
41 40. Any excess of the cost of the acquisition over the acquirer's interest in the fair value of the identifiable assets and liabilities acquired as at the date of the exchange transaction should be described as goodwill and recognized as an asset.
42 41. Goodwill arising on acquisition represents a payment made by the acquirer in anticipation of future economic benefits. The future economic benefits may result from synergy between the identifiable assets acquired or from assets which, individually, do not qualify for recognition in the financial statements but for which the acquirer is prepared to make a payment in the acquisition.
43. Goodwill should be carried at cost less any accumulated amortization and any
accumulated impairment losses.
Amortization
44. Goodwill should be amortized on a systematic basis over its useful life. The amortization period should reflect the best estimate of the period during which future economic benefits are expected to flow to the enterprise. There is a rebuttable presumption that the useful life of goodwill will not exceed twenty years from initial recognition.
45. The amortization method used should reflect the pattern in which the future economic benefits arising from goodwill are expected to be consumed. The straight-line method should be adopted unless there is persuasive evidence that another method is more appropriate in the circumstances.
46. The amortization for each period should be recognized as an expense.
42. Goodwill should be amortized by recognizing it as an expense over its useful life. In amortizing goodwill, the straight-line basis should be used unless another amortization method is more appropriate in the circumstances. The amortization period should not exceed five years unless a longer period, not exceeding twenty years from the date of acquisition, can be justified.
47 43. With the passage of time, goodwill diminishes, reflecting the fact that its service potential is decreasing its reduced capacity to contribute to the future income of the enterprise. In some cases, the value of goodwill may appear not to decrease over time. This is because the potential for economic benefits that was purchased initially is being progressively replaced by the potential for economic benefits resulting from subsequent enhancements of goodwill. In other words, the goodwill that was purchased is being replaced by internally generated goodwill. IAS 38, Intangible Assets, prohibits the recognition of internally generated goodwill as an asset. Therefore, it is appropriate that goodwill is amortized and charged as an expense on a systematic basis over the best estimate of its useful life.
48 44. Factors Many factors need to be considered in estimating the useful life of
goodwill including include:
(a) the nature and foreseeable life of the acquired business or industry;
(b) the stability and foreseeable life of the industry to which the goodwill
relates;
(c) public information on the characteristics of goodwill in similar businesses or
industries and typical lifecycles of similar businesses;
(db) the effects of product obsolescence, changes in demand and other economic factors on
the acquired business;
(ec) the service life expectancies of key individuals or groups of employees and whether
the acquired business could be efficiently managed by another management team;
(f) the level of maintenance expenditure or of funding required to obtain the expected
future economic benefits from the acquired business and the company's ability and intent
to reach such a level;
(gd) expected actions by competitors or potential competitors; and
(he) the period of control over the acquired business and legal, regulatory or contractual
provisions affecting its the useful life.
49 45. Because goodwill represents, among other things, future economic benefits from synergy or assets that cannot be recognized separately for which separate recognition is not possible, it is frequently difficult to estimate its useful life. Estimates of its useful life become less reliable as the length of the useful life increases. Therefore, for accounting purposes, this Standard specifies an arbitrary limit on the amortization period. The presumption in this Standard is that goodwill does not normally have a useful life in excess of twenty five years from initial recognition. However, there may be circumstances when the goodwill is so clearly related to an identifiable asset that it can reasonably be expected to benefit the acquirer over the useful life of the identifiable asset. This may be the case, for example, when the principal identifiable asset in the acquisition is a broadcasting license with a term longer than five years. After recording the fair value of the broadcasting license as an asset, any goodwill arising on the acquisition is amortized over the period of the broadcasting license. Nevertheless, since an enterprise's planning horizon with respect to its operations as a whole is unlikely to exceed twenty years, projections as to the life of goodwill beyond this period are not sufficiently reliable to permit an amortization period of longer than twenty years.
50. In rare cases, there may be persuasive evidence that the useful life of goodwill
will be a specific period longer than twenty years. Although examples are difficult to
find, this may occur when the goodwill is so clearly related to an identifiable asset or a
group of identifiable assets that it can reasonably be expected to benefit the acquirer
over the useful life of the identifiable asset or group of assets. In these cases, the
presumption that the useful life of goodwill will not exceed twenty years is rebutted and
the enterprise:
(a) amortizes the goodwill over the best estimate of its useful life;
(b) estimates the recoverable amount of the goodwill at least annually to identify any
impairment loss (see paragraph 56); and
(c) discloses the reasons why the presumption is rebutted and the factor(s) that played a
significant role in determining the useful life of the goodwill (see paragraph
88(b)).
51. The useful life of goodwill is always finite. Uncertainty justifies estimating the useful life of goodwill on a prudent basis, but it does not justify estimating a useful life that is unrealistically short.
52. There will rarely, if ever, be persuasive evidence to support an amortization method for goodwill other than the straight-line basis, especially if that other method results in a lower amount of accumulated amortization than under the straight-line method. The amortization method is applied consistently from period to period unless there is a change in the expected pattern of economic benefits from goodwill.
53 46. When initially accounting for an the acquisition, there may be circumstances in which the goodwill on acquisition does not reflect future economic benefits that are expected to flow to the acquirer. This is the case when, For example, since negotiating the purchase consideration, there may have has been a decline in the expected future cash flows from the net identifiable assets being acquired. In this case, an enterprise tests the goodwill for impairment under IAS 36, Impairment of Assets, and accounts for any impairment loss accordingly. A discovery that an error in the accounts existed, as a result of fraud, at the date of acquisition is a further example of when goodwill on acquisition may not reflect future economic benefits. In these circumstances, goodwill is written down and an expense recognized immediately.
54. The amortization period and the amortization method should be reviewed at least at each financial year end. If the expected useful life of goodwill is significantly different from previous estimates, the amortization period should be changed accordingly. If there has been a significant change in the expected pattern of economic benefits from goodwill, the method should be changed to reflect the changed pattern. Such changes should be accounted for as changes in accounting estimates under IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies, by adjusting the amortization charge for the current and future periods.
Recoverability of the Carrying Amount - Impairment Losses
55. To determine whether goodwill is impaired, an enterprise applies IAS 36, Impairment of Assets. IAS 36 explains how an enterprise reviews the carrying amount of its assets, how it determines the recoverable amount of an asset and when it recognizes or reverses an impairment loss.
56. In addition to following the requirements included in IAS 36, Impairment of Assets, an enterprise should, at least at each financial year end, estimate in accordance with IAS 36 the recoverable amount of goodwill that is amortized over a period exceeding twenty years from initial recognition, even if there is no indication that it is impaired.
57. It is sometimes difficult to identify whether goodwill is impaired, particularly if it has a long useful life. As a consequence, this Standard requires, as a minimum, an annual calculation of the recoverable amount of goodwill if its useful life exceeds twenty years from initial recognition.
58. The requirement for an annual impairment test of goodwill applies whenever the current total estimated useful life of the goodwill exceeds twenty years from its initial recognition. Therefore, if the useful life of goodwill was estimated to be less than twenty years at initial recognition, but the estimated useful life is subsequently extended to exceed twenty years from when the goodwill was initially recognized, an enterprise performs the impairment test required under paragraph 56 and gives the disclosure required under paragraph 88(b).
47. The unamortized balance of goodwill should be reviewed at each balance sheet date and, to the extent that it is no longer probable of being recovered from the expected future economic benefits, it should be recognized immediately as an expense. Any write-down of goodwill should not be reversed in a subsequent period.
48. An impairment in the value of goodwill may be caused by factors such as unfavorable economic trends, changes in the competitive situation and legal, statutory or contractual proceedings. It may be evidenced by a reduction in the cash flows generated, or reasonably likely to be generated, by the acquiree's business. In these circumstances, the carrying amount of goodwill is written down and an expense recognized.
Negative Goodwill Arising on Acquisition
Recognition and Measurement
59. Any excess, as at the date of the exchange transaction, of the acquirer's interest in the fair values of the identifiable assets and liabilities acquired over the cost of the acquisition, should be recognized as negative goodwill.
60. The existence of negative goodwill may indicate that identifiable assets have been overstated and identifiable liabilities have been omitted or understated. It is important to ensure that this is not the case before negative goodwill is recognized.
61. To the extent that negative goodwill relates to expectations of future losses and expenses that are identified in the acquirer's plan for the acquisition and can be measured reliably, but which do not represent identifiable liabilities at the date of acquisition (see paragraph 26), that portion of negative goodwill should be recognized as income in the income statement when the future losses and expenses are recognized. If these identifiable future losses and expenses are not recognized in the expected period, negative goodwill should be treated under paragraph 62 (a) and (b).
62. To the extent that negative goodwill does not relate to identifiable expected
future losses and expenses that can be measured reliably at the date of acquisition,
negative goodwill should be recognized as income in the income statement as follows:
(a) the amount of negative goodwill not exceeding the fair values of acquired identifiable
non-monetary assets should be recognized as income on a systematic basis over the
remaining weighted average useful life of the identifiable acquired depreciable/
amortizable assets; and
(b) the amount of negative goodwill in excess of the fair values of acquired identifiable
non-monetary assets should be recognized as income immediately.
63. To the extent that negative goodwill does not relate to expectations of future losses and expenses that have been identified in the acquirer's plan for the acquisition and can be measured reliably, negative goodwill is a gain which is recognized as income when the future economic benefits embodied in the identifiable depreciable/amortizable assets acquired are consumed. In the case of monetary assets, the gain is recognized as income immediately.
Presentation
64. Negative goodwill should be presented as a deduction from the assets of the reporting enterprise, in the same balance sheet classification as goodwill.
Benchmark Treatment
49. When the cost of the acquisition is less than the acquirer's interest in the fair values of the identifiable assets and liabilities acquired as at the date of the exchange transaction, the fair values of the non-monetary assets acquired should be reduced proportionately until the excess is eliminated. When it is not possible to eliminate completely the excess by reducing the fair values of non-monetary assets acquired, the excess which remains should be described as negative goodwill and treated as deferred income. It should be recognized as income on a systematic basis over a period not exceeding five years unless a longer period, not exceeding twenty years from the date of acquisition, can be justified.
50. When the acquirer's interest in the aggregate fair values of the identifiable net assets acquired exceeds the cost of the acquisition, the net assets acquired have effectively been acquired at a discount. Accordingly, the fair values of the non-monetary assets acquired are reduced by the discount to ensure that the acquisition is not recorded at more than its cost. The total discount, spread over those assets, will be realized as income when the assets concerned are sold or as the future economic benefits embodied therein are consumed. In the case of current assets, such as inventory, the realization process is completed as the inventory is sold. In the case of long-term assets, such as plant and equipment, the discount is realized through lower depreciation charges over the useful life of the asset.
Allowed Alternative Treatment
51. Any excess, as at the date of the exchange transaction, of the acquirer's interest
in the fair values of the identifiable assets and liabilities acquired over the cost of
the acquisition, should be described as negative goodwill and treated as deferred income.
It should be recognized as income on a systematic basis over a period not exceeding five
years unless a longer period, not exceeding twenty years from the date of acquisition, can
be justified.
Adjustments to Purchase Consideration Contingent on Future Events
65 52. When the acquisition agreement provides for an adjustment to the purchase consideration contingent on one or more future events, the amount of the adjustment should be included in the cost of the acquisition as at the date of acquisition if the adjustment is probable and the amount can be measured reliably.
66 53. Acquisition agreements may allow for adjustments to be made to the purchase consideration in the light of one or more future events. The adjustments may be contingent on a specified level of earnings being maintained or achieved in future periods or on the market price of the securities issued as part of the purchase consideration being maintained.
67 54. When initially accounting for an acquisition, it is usually possible to estimate the amount of any adjustment to the purchase consideration, even though some uncertainty exists, without impairing the reliability of the information. If the future events do not occur, or the estimate needs to be revised, the cost of the acquisition is adjusted with a consequential effect on goodwill, or negative goodwill, as the case may be.
Subsequent Changes in Cost of Acquisition
68 55. The cost of the acquisition should be adjusted when a contingency affecting the amount of the purchase consideration is resolved subsequent to the date of the acquisition, so that payment of the amount is probable and a reliable estimate of the amount can be made.
69 56. The terms of an acquisition may provide for an adjustment of the purchase consideration if the results from the acquiree's operations exceed or fall short of an agreed level after acquisition. When the adjustment subsequently becomes probable and a reliable estimate can be made of the amount, the acquirer treats the additional consideration as an adjustment to the cost of acquisition, with a consequential effect on goodwill, or negative goodwill, as the case may be.
70 57. In some circumstances, the acquirer may be required to make subsequent payment to the seller as compensation for a reduction in the value of the purchase consideration. This is the case when the acquirer has guaranteed the market price of securities or debt issued as consideration and has to make a further issue of securities or debt for the purpose of restoring the originally determined cost of acquisition. In such cases, there is no increase in the cost of acquisition and, consequently, no adjustment to goodwill or negative goodwill. Instead, the increase in securities or debt issued represents a reduction in the premium or an increase in the discount on the initial issue.
Subsequent Identification or Changes in Value of Identifiable Assets and Liabilities
71 58. Assets Identifiable assets and liabilities, which are acquired but which do not
satisfy the criteria in paragraph 26 27 for separate recognition when the acquisition is
initially accounted for, should be recognized subsequently as and when they satisfy the
criteria. The carrying amounts of identifiable assets and liabilities acquired should be
adjusted when, subsequent to acquisition, additional evidence becomes available to assist
with the estimation of the amounts assigned to those identifiable assets and liabilities
when the acquisition was initially accounted for. The amount assigned to goodwill or
negative goodwill amount should also be adjusted, when necessary, to the extent provided
that:
(a) the adjustment does not increase the carrying amount of goodwill above its recoverable
amount, as defined in IAS 36, Impairment of Assets; the amount of the adjustment is
probable of being recovered from the expected future economic benefits and
(b) such adjustment is made by the end of the first annual accounting period commencing
after acquisition (except for the recognition of an identifiable liability under paragraph
31, for which the time-frame in paragraph 31(c) applies);
otherwise the adjustments to the identifiable assets and liabilities should be recognized
as income or expense.
72 59. Assets Identifiable assets and liabilities of an acquiree may not have been recognized at the time of acquisition because they did not meet the recognition criteria for identifiable assets and liabilities or the acquirer was unaware of their existence. Similarly, the fair values assigned at the date of acquisition to the identifiable assets and liabilities acquired may need to be adjusted as additional evidence becomes available to assist with the estimation of the value of the identifiable asset or liability at the date of acquisition. When the identifiable assets or liabilities are recognized or the carrying amounts are adjusted after the end of the first annual accounting period (excluding interim periods) commencing after acquisition, income or expense is recognized rather than an adjustment to goodwill or negative goodwill. This time-limit, while arbitrary in its length, prevents goodwill and negative goodwill from being reassessed and adjusted indefinitely.
73. Under paragraph 71, the carrying amount of goodwill (negative goodwill) is adjusted if, for example, there is an impairment loss before the end of the first annual accounting period commencing after acquisition for an identifiable asset acquired and the impairment loss does not relate to specific events or changes in circumstances occurring after the date of acquisition.
74 60. When, subsequent to acquisition but prior to the end of the first annual accounting period (excluding interim periods) commencing after acquisition, the acquirer becomes aware of the existence of a liability which had existed at the date of acquisition or of an impairment loss that does not relate to specific events or changes in circumstances occurring after the date of acquisition, goodwill is not increased above its recoverable amount determined under IAS 36 without assessing whether additional future economic benefits can be expected. If additional future economic benefits cannot be expected, the amount is recognized as an expense.
75. If provisions for terminating or reducing activities of the acquiree were
recognized under paragraph 31, these provisions should be reversed if, and only if:
(a) the outflow of economic benefits is no longer probable; or
(b) the detailed formal plan is not implemented:
(i) in the manner set out in the detailed formal plan; or
(ii) within the time established in the detailed formal plan.
Such a reversal should be reflected as an adjustment to goodwill or negative goodwill (and
minority interests, if appropriate), so that no income or expense is recognized in respect
of it. The adjusted amount of goodwill should be amortized prospectively over its
remaining useful life. The adjusted amount of negative goodwill should be dealt with under
paragraph 62(a) and (b).
76. No subsequent adjustment is normally necessary in respect of provisions recognized under paragraph 31, as the detailed formal plan is required to identify the expenditures that will be undertaken. If the expenditures have not occurred in the expected period, or are no longer expected to occur, it is necessary to adjust the provision for terminating or reducing activities of the acquiree, with a corresponding adjustment to the amount of goodwill or negative goodwill (and minority interests, if appropriate). If subsequently, there is any obligation that is required to be recognized under IAS 37, Provisions, Contingent Liabilities and Contingent Assets, the enterprise recognizes a corresponding expense.
Unitings of Interests
Accounting for Unitings of Interests
77 61. A uniting of interests should be accounted for by use of the pooling of interests method as set out in paragraphs 78 62, 79 63 and 82 66.
78 62. In applying the pooling of interests method, the financial statement items of the combining enterprises for the period in which the combination occurs and for any comparative periods disclosed should be included in the financial statements of the combined enterprises as if they had been combined from the beginning of the earliest period presented. The financial statements of an enterprise should not incorporate a uniting of interests to which the enterprise is a party if the date of the uniting of interests is after the date of the most recent balance sheet included in the financial statements.
79 63. Any difference between the amount recorded as share capital issued plus any additional consideration in the form of cash or other assets and the amount recorded for the share capital acquired should be adjusted against equity.
80 64. The substance of a uniting of interests is that no acquisition has occurred and there has been a continuation of the mutual sharing of risks and benefits that existed prior to the business combination. Use of the pooling of interests method recognizes this by accounting for the combined enterprises as though the separate businesses were continuing as before, though now jointly owned and managed. Accordingly, only minimal changes are made in aggregating the individual financial statements.
81 65. Since a uniting of interests results in a single combined entity, a single uniform set of accounting policies is adopted by that entity. Therefore, the combined entity recognizes the assets, liabilities and equity of the combining enterprises at their existing carrying amounts adjusted only as a result of conforming the combining enterprises' accounting policies and applying those policies to all periods presented. There is no recognition of any new goodwill or negative goodwill. Similarly, the effects of all transactions between the combining enterprises, whether occurring before or after the uniting of interests, are eliminated in preparing the financial statements of the combined entity.
82 66. Expenditures incurred in relation to a uniting of interests should be recognized as expenses in the period in which they are incurred.
83 67. Expenditures incurred in relation to a uniting of interests include registration fees, costs of furnishing information to shareholders, finders and consultants fees, and salaries and other expenses related to services of employees involved in achieving the business combination. They also include any costs or losses incurred in combining operations of the previously separate businesses.
All Business Combinations
Taxes on Income
84 68. In some countries, the accounting treatment for a business combination may differ from that applied under their respective income tax laws. Any resulting deferred tax liabilities and deferred tax assets are recognized under IAS 12, Income Taxes. Permanent or timing differences which arise between recognition of income or expenses for financial reporting and for tax purposes are recognized in accordance with IAS 12, Accounting for Taxes on Income.
85 69. The potential benefit of income tax loss carryforwards, or other deferred tax
assets, of an acquired enterprise, which were not recognized as an identifiable asset by
the acquirer at the date of acquisition, may subsequently be realized. When this occurs,
the acquirer recognizes the benefit as income under in accordance with IAS 12, Income
Taxes. In addition, the acquirer:
(a) adjusts the gross carrying amount of the goodwill and the related accumulated
amortization to the amounts that would have been recorded if the deferred tax asset had
been recognized as an identifiable asset at the date of the business combination; and
(b) recognizes the reduction in the net carrying amount of the goodwill as an expense.
However, this procedure does not create negative goodwill, nor does it increase the
carrying amount of negative goodwill.
Disclosure
86 70. For all business combinations, the following disclosures should be made in the
financial statements for the period during which the combination has taken place:
(a) the names and descriptions of the combining enterprises;
(b) the method of accounting for the combination;
(c) the effective date of the combination for accounting purposes; and
(d) any operations resulting from the business combination which the enterprise has
decided to dispose of.
87 71. For a business combination which is an acquisition, the following additional
disclosures should be made in the financial statements for the period during which the
acquisition has taken place:
(a) the percentage of voting shares acquired; and
(b) the cost of acquisition and a description of the purchase consideration paid or
contingently payable.; and
(c) the nature and amount of provisions for restructuring and other plant closure expenses
arising as a result of the acquisition and recognized as at the date of the acquisition.
88 72. The For goodwill, the financial statements should disclose:
(a) the amortization period(s) adopted the accounting treatment for goodwill and negative
goodwill, including the period of amortization;
(b) if goodwill is amortized over more than twenty years, the reasons why the presumption
that the useful life of goodwill will not exceed twenty years from initial recognition is
rebutted. In giving these reasons, the enterprise should describe the factor(s) that
played a significant role in determining the useful life of the goodwill when the useful
life of goodwill or the amortization period for negative goodwill exceeds five years,
justification of the period adopted;
(c) when if goodwill or negative goodwill is not amortized on the straight-line basis, the
basis used and reason why that basis is more appropriate than the straight-line basis; and
(d) the line item(s) of the income statement in which the amortization of goodwill is
included; and
(ed) a reconciliation, in respect of the carrying amount of both goodwill and negative
goodwill, at the beginning and end of the period showing:
(i) the gross amount and the accumulated amortization (aggregated with accumulated
impairment losses), at the beginning of the period;
(ii) any additional goodwill recognized or negative goodwill recorded during the period;
(iii) amortization charged during the period;
(iiiiv) any adjustments resulting from subsequent identification or changes in value of
identifiable assets and liabilities;
(iv) any goodwill derecognized on the disposal of all or part of the business to which it
relates during the period;
(v) amortization recognized during the period;
(vi) impairment losses recognized during the period under IAS 36, Impairment of Assets (if
any);
(vii) impairment losses reversed during the period under IAS 36 (if any);
(viii) other changes in the carrying amount during the period (if any); and
(v) any other write-offs during the period; and
(ixvi) the gross amount and the accumulated amortization (aggregated with accumulated
impairment losses), at the end of the period.
Comparative information is not required.
89. When an enterprise describes the factor(s) that played a significant role in determining the useful life of goodwill that is amortized over more than twenty years, the enterprise considers the list of factors in paragraph 48.
90. An enterprise discloses information on impaired goodwill under IAS 36 in addition to the information required by paragraph 88(e)(vi) and (vii).
91. For negative goodwill, the financial statements should disclose:
(a) to the extent that negative goodwill is treated under paragraph 61, a description, the
amount and the timing of the expected future losses and expenses;
(b) the period(s) over which negative goodwill is recognized as income;
(c) the line item(s) of the income statement in which negative goodwill is recognized as
income; and
(d) a reconciliation of the carrying amount of negative goodwill at the beginning and end
of the period showing:
(i) the gross amount of negative goodwill and the accumulated amount of negative goodwill
already recognized as income, at the beginning of the period;
(ii) any additional negative goodwill recognized during the period;
(iii) any adjustments resulting from subsequent identification or changes in value of
identifiable assets and liabilities;
(iv) any negative goodwill derecognized on the disposal of all or part of the business to
which it relates during the period;
(v) negative goodwill recognized as income during the period, showing separately the
portion of negative goodwill recognized as income under paragraph 61 (if any);
(vi) other changes in the carrying amount during the period (if any); and
(vii) the gross amount of negative goodwill and the accumulated amount of negative
goodwill already recognized as income, at the end of the period.
Comparative information is not required.
92. The disclosure requirements of IAS 37, Provisions, Contingent Liabilities and Contingent Assets, apply to provisions recognized under paragraph 31 for terminating or reducing the activities of an acquiree. These provisions should be treated as a separate class of provisions for the purpose of disclosure under IAS 37. In addition, the aggregate carrying amount of these provisions should be disclosed for each individual business combination.
93 73. In an acquisition, if the fair values of the identifiable assets and liabilities or the purchase consideration can only be determined on a provisional basis at the end of the period in which the acquisition took place, this should be stated and reasons given. When there are subsequent adjustments to such provisional fair values, those adjustments should be disclosed and explained in the financial statements of the period concerned.
94 74. For a business combination which is a uniting of interests, the following
additional disclosures should be made in the financial statements for the period during
which the uniting of interests has taken place:
(a) description and number of shares issued, together with the percentage of each
enterprise's voting shares exchanged to effect the uniting of interests;
(b) amounts of assets and liabilities contributed by each enterprise; and
(c) sales revenue, other operating revenues, extraordinary items and the net profit or
loss of each enterprise prior to the date of the combination that are included in the net
profit or loss shown by the combined enterprise's financial statements.
95 75. General disclosures required to be made in consolidated financial statements are contained in IAS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries.
96 76. For business combinations effected after the balance sheet date, the information required by paragraphs 86 70 to 94 74 should be disclosed. If it is impracticable to disclose any of this information, this fact should be disclosed.
97 77. Business combinations which have been effected after the balance sheet date and before the date on which the financial statements of one of the combining enterprises are authorized for issue are disclosed if they are of such importance that non-disclosure would affect the ability of the users of the financial statements to make proper evaluations and decisions (see IAS 10, Contingencies and Events Occurring After the Balance Sheet Date).
98 78. In certain circumstances, the effect of the combination may be to allow the financial statements of the combined enterprise to be prepared in accordance with the going concern assumption. This might not have been possible for one or both of the combining enterprises. This may occur, for example, when an enterprise with cash flow difficulties combines with an enterprise having access to cash that can be used in the enterprise with a need for cash. If this is the case, disclosure of this information in the financial statements of the enterprise having the cash flow difficulties is relevant.
Transitional Provisions
99. At the date when this Standard becomes effective (or at the date of adoption, if earlier), it should be applied as set out in the following tables. In all cases other than those detailed in these tables, this Standard should be applied retrospectively, unless it is impracticable to do so.
100. The effect of adopting this Standard on its effective date (or earlier) should be recognized under IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies, that is, as an adjustment either to the opening balance of retained earnings of the earliest period presented (IAS 8 benchmark treatment) or to the net profit or loss for the current period (IAS 8 allowed alternative treatment).
101. In the first annual financial statements issued under this Standard, an enterprise should disclose the transitional provisions adopted where transitional provisions under this Standard permit a choice.
79. Retrospective application of this Standard is encouraged but not required. If the Standard is not applied retrospectively, the balance of any pre-existing goodwill or negative goodwill is deemed to have been properly determined and should be accounted for thereafter in accordance with the provisions of this Standard. The amortization period for pre-existing goodwill or negative goodwill should be the shorter of the remaining life as specified in the enterprise's amortization policy and the amortization period specified in this Standard.
Transitional Provisions - Restatement of Goodwill and Negative Goodwill
Circumstances Requirements
1. Business combination that was an acquisition and arose in annual financial
statements covering periods beginning before 1 January 1995.
(a) Goodwill (negative goodwill) was Restatement of the goodwill (negative
written off against reserves. goodwill) is encouraged, but not required.
If the goodwill (negative goodwill) is restated:
(i) restate goodwill and negative goodwill
for all acquisitions before 1 January
1995;
(ii) determine the amount assigned to the
goodwill (negative goodwill) at the
date of acquisition under paragraph
41 (59) of this Standard and recognize
the goodwill (negative goodwill)
accordingly; and
(iii) determine the accumulated amortization
of the goodwill (the accumulated amount
of negative goodwill recognized as
income) since the date of acquisition
under paragraphs 44-54 (61-63) of this
Standard and recognize it accordingly.
(b) Goodwill (negative goodwill) was Restatement of the goodwill (negative
recognized initially as an asset goodwill) is encouraged, but not required.
(deferred income) but not at the
amount that would have been If the goodwill (negative goodwill) is
assigned under paragraph 41 (59) of restated, apply the requirements under
this Standard. circumstances 1(a) above.
If the goodwill (negative goodwill) is not
assigned to the goodwill (negative goodwill)
at the date of acquisition is deemed to have
been properly determined. For the
amortization of goodwill (recognition of
negative goodwill as income), see
circumstances 3 or 4 below.
2. Business combination that was an acquisition and arose in annual financial
statements covering periods beginning on or after 1 January 1995, but before this
Standard is effective (or before the date of adoption of this Standard, if earlier).
(a) At the date of acquisition, the If the goodwill was recognized as an asset
cost of the acquisition exceeded the and the amount assigned to it at the date of
acquirer's interest in the fair value of acquisition was determined under paragraph
the identifiable assets and liabilities. 41 of this Standard, see transitional
provisions for amortization under
circumstances 3 or 4 below.
Otherwise:
(i) determine the amount that would have
been assigned to the goodwill at the
date of acquisition under paragraph 41
of this Standard and recognize the
goodwill accordingly;
(ii) determine the related accumulated
amortization of the goodwill that would
have been recognized under IAS 22
(revised 1993) and recognize it
accordingly (the twenty year limit in
IAS 22 (revised 1993) applies); and
(iii) amortize any remaining carrying
amount of the goodwill over its
remaining useful life determined under
this Standard (treatment as in
circumstances 4 below).
(b) At the date of acquisition: Restatement of the negative goodwill is
encouraged, but not required. If the
(i) the cost of the acquisition was negative goodwill is restated:
less than the acquirer's interest in
the fair value of the identifiable (i) restate negative goodwill for all
assets and liabilities; and acquisitions after 1 January 1995;
(ii) the fair values of the identifiable (ii) determine the amount that would have
non-monetary assets acquired been assigned to the negative goodwill
were reduced until the excess was at the date of acquisition under
eliminated (benchmark treatment paragraph 59 of this Standard and
under IAS 22 (revised 1993)). recognize the negative goodwill
accordingly;
(iii) determine the related accumulated
amount of negative goodwill that would
have been recognized as income under
IAS 22 (revised 1993) and recognize it
accordingly; and
(iv) recognize any remaining carrying
amount of the negative goodwill as
income over the remaining weighted
average useful life of the identifiable
depreciable/amortizable
non-monetary assets acquired (treatment
as in circumstances 4 below).
If the negative goodwill is not restated, the
amount assigned to the negative goodwill
(if any) at the date of acquisition is deemed
to have been properly determined. For the
recognition of negative goodwill as income,
see circumstances 3 or 4 below.
(c) At the date of acquisition: If the negative goodwill was recognized and
the amount assigned to it at the date of
(i) the cost of the acquisition was acquisition was determined under paragraph
less than the acquirer's interest in 59 of this Standard, see transitional
the fair value of the identifiable provisions for the recognition of negative
assets and liabilities; and goodwill as income under circumstances 3
and 4 below. Otherwise:
(ii) the fair values of the identifiable
non-monetary assets acquired were (i) determine the amount that would have
not reduced to eliminate the excess been assigned to the negative goodwill
(allowed alternative treatment under at the date of acquisition under
IAS 22 (revised 1993)). paragraph 59 of this Standard and
recognize the negative goodwill
accordingly;
(ii) determine the related accumulated
amount of the negative goodwill that
would have been recognized as income
under IAS 22 (revised 1993) and
recognize it accordingly; and
(iii) recognize any remaining carrying
amount of the negative goodwill as
income over the remaining weighted
average useful life of the identifiable
depreciable/amortizable non-monetary
assets acquired (treatment as in
circumstances 4 below).
3. Goodwill was recognized as an Restate the carrying amount of the goodwill
asset but was not previously (negative goodwill) as if the amortization of
amortized or the amortization charge goodwill (amount of negative goodwill
was deemed to be nil. recognized as income) had always been
determined under this Standard (see
Negative goodwill was recognized paragraphs 44-54 (61-63)).
initially as a separate item in the
balance sheet but was not
subsequently recognized as income
or the amount of negative goodwill
to be recognized as income was
deemed to be nil.
4. Goodwill (negative goodwill) was Do not restate the carrying amount of the
previously amortized (recognized as goodwill (negative goodwill) for any
income). difference between accumulated
amortization (accumulated negative
goodwill recognized as income) in prior
years and that calculated under this
Standard and:
(i) amortize any carrying amount of the
goodwill over its remaining useful life
determined under this Standard (see
paragraphs 44-54); and
(ii) recognize any carrying amount of the
negative goodwill as income over the
remaining weighted average useful life
of the identifiable depreciable/
amortizable non-monetary assets
acquired (see paragraph 62(a)).
(i.e. any change is treated in the same way
as a change in accounting estimate under
IAS 8, Net Profit or Loss for the Period,
Fundamental Errors and Changes in
Accounting Policies).
Effective Date
102 96.This International Accounting Standard becomes operative for annual financial
statements covering periods beginning on or after 1 July 1999 1 January 1995. Earlier
application is encouraged. If an enterprise applies this Standard for annual financial
statements covering periods beginning before 1 July 1999, the enterprise should:
(a) disclose that fact; and
(b) adopt IAS 36, Impairment of Assets, IAS 37, Provisions, Contingent Liabilities and
Contingent Assets, and IAS 38, Intangible Assets, at the same time.
103. This Standard supersedes IAS 22, Business Combinations, approved in 1993.
IAS 10 (revised 1999)
Events After the Balance Sheet Date (effective 1 January 2000)
Introduction
IAS 10, Events After the Balance Sheet Date, replaces those parts of IAS 10,
Contingencies and Events Occurring After the Balance Sheet Date, that have not already
been superseded by IAS 37, Provisions, Contingent Liabilities and Contingent Assets. The
new Standard makes the following limited changes:
(a) new disclosures about the date of the authorization of the financial statements for
issue;
(b) deletion of the option to recognize a liability for dividends that are stated to be in
respect of the period covered by the financial statements and are proposed or declared
after the balance sheet date but before the financial statements are authorized for issue.
An enterprise may give the required disclosure of such dividends either on the face of the
balance sheet as a separate component of equity or in the notes to the financial
statements;
(c) confirmation that an enterprise should update disclosures that relate to conditions
that existed at the balance sheet date in the light of any new information that it
receives after the balance sheet date about those conditions;
(d) deletion of the requirement to adjust the financial statements where an event after
the balance sheet date indicates that the going concern assumption is not appropriate for
part of the enterprise. Under IAS 1, Presentation of Financial Statements, the going
concern assumption applies to an enterprise as a whole;
(e) certain refinements to the examples of adjusting and non-adjusting events; and
(f) various drafting improvements.
International Accounting Standard IAS 10 (revised 1999)
Events After the Balance Sheet Date
The standards, which have been set in bold italic type, should be read in the context of
the background material and implementation guidance in this Standard, and in the context
of the Preface to International Accounting Standards. International Accounting Standards
are not intended to apply to immaterial items (see paragraph 12 of the Preface).
Objective
The objective of this Standard is to prescribe:
(a) when an enterprise should adjust its financial statements for events after the balance
sheet date; and
(b) the disclosures that an enterprise should give about the date when the financial
statements were authorized for issue and about events after the balance sheet date.
The Standard also requires that an enterprise should not prepare its financial statements
on a going concern basis if events after the balance sheet date indicate that the going
concern assumption is not appropriate.
Scope
1. This Standard should be applied in the accounting for, and disclosure of, events after the balance sheet date.
Definitions
2. The following terms are used in this Standard with the meanings specified:
Events after the balance sheet date are those events, both favorable and unfavorable, that
occur between the balance sheet date and the date when the financial statements are
authorized for issue. Two types of events can be identified:
(a) those that provide evidence of conditions that existed at the balance sheet date
(adjusting events after the balance sheet date); and
(b) those that are indicative of conditions that arose after the balance sheet date
(non-adjusting events after the balance sheet date).
3. The process involved in authorizing the financial statements for issue will vary depending upon the management structure, statutory requirements and procedures followed in preparing and finalizing the financial statements.
4. In some cases, an enterprise is required to submit its financial statements to its shareholders for approval after the financial statements have already been issued. In such cases, the financial statements are authorized for issue on the date of original issuance, not on the date when shareholders approve the financial statements.
Example
The management of an enterprise completes draft financial statements for the year to 31
December 20X1 on 28 February 20X2. On 18 March 20X2, the board of directors reviews the
financial statements and authorizes them for issue. The enterprise announces its profit
and selected other financial information on 19 March 20X2. The financial statements are
made available to shareholders and others on 1 April 20X2. The annual meeting of
shareholders approves the financial statements on 15 May 20X2 and the approved financial
statements are then filed with a regulatory body on 17 May 20X2.
The financial statements are authorized for issue on 18 March 20X2 (date of Board
authorization for issue).
5. In some cases, the management of an enterprise is required to issue its financial statements to a supervisory board (made up solely of non-executives) for approval. In such cases, the financial statements are authorized for issue when the management authorizes them for issue to the supervisory board.
Example
On 18 March 20X2, the management of an enterprise authorizes financial statements for
issue to its supervisory board. The supervisory board is made up solely of non-executives
and may include representatives of employees and other outside interests. The supervisory
board approves the financial statements on 26 March 20X2. The financial statements are
made available to shareholders and others on 1 April 20X2. The annual meeting of
shareholders receives the financial statements on 15 May 20X2 and the financial statements
are then filed with a regulatory body on 17 May 20X2.
The financial statements are authorized for issue on 18 March 20X2 (date of management
authorization for issue to the supervisory board).
6. Events after the balance sheet date include all events up to the date when the financial statements are authorized for issue, even if those events occur after the publication of a profit announcement or of other selected financial information.
Recognition and Measurement
Adjusting Events After the Balance Sheet Date
7. An enterprise should adjust the amounts recognized in its financial statements to reflect adjusting events after the balance sheet date.
8. The following are examples of adjusting events after the balance sheet date that
require an enterprise to adjust the amounts recognized in its financial statements, or to
recognize items that were not previously recognized:
(a) the resolution after the balance sheet date of a court case which, because it confirms
that an enterprise already had a present obligation at the balance sheet date, requires
the enterprise to adjust a provision already recognized, or to recognize a provision
instead of merely disclosing a contingent liability;
(b) the receipt of information after the balance sheet date indicating that an asset was
impaired at the balance sheet date, or that the amount of a previously recognized
impairment loss for that asset needs to be adjusted. For example:
(i) the bankruptcy of a customer which occurs after the balance sheet date usually
confirms that a loss already existed at the balance sheet date on a trade receivable
account and that the enterprise needs to adjust the carrying amount of the trade
receivable account; and
(ii) the sale of inventories after the balance sheet date may give evidence about their
net realizable value at the balance sheet date;
(c) the determination after the balance sheet date of the cost of assets purchased, or the
proceeds from assets sold, before the balance sheet date;
(d) the determination after the balance sheet date of the amount of profit sharing or
bonus payments, if the enterprise had a present legal or constructive obligation at the
balance sheet date to make such payments as a result of events before that date (see IAS
19, Employee Benefits); and
(e) the discovery of fraud or errors that show that the financial statements were
incorrect.
Non-Adjusting Events After the Balance Sheet Date
9. An enterprise should not adjust the amounts recognized in its financial statements to reflect non-adjusting events after the balance sheet date.
10. An example of a non-adjusting event after the balance sheet date is a decline in market value of investments between the balance sheet date and the date when the financial statements are authorized for issue. The fall in market value does not normally relate to the condition of the investments at the balance sheet date, but reflects circumstances that have arisen in the following period. Therefore, an enterprise does not adjust the amounts recognized in its financial statements for the investments. Similarly, the enterprise does not update the amounts disclosed for the investments as at the balance sheet date, although it may need to give additional disclosure under paragraph 20.
Dividends
11. If dividends to holders of equity instruments (as defined in IAS 32, Financial Instruments: Disclosure and Presentation) are proposed or declared after the balance sheet date, an enterprise should not recognize those dividends as a liability at the balance sheet date.
12. IAS 1, Presentation of Financial Statements, requires an enterprise to disclose the
amount of dividends that were proposed or declared after the balance sheet date but before
the financial statements were authorized for issue. IAS 1 permits an enterprise to make
this disclosure either:
(a) on the face of the balance sheet as a separate component of equity; or
(b) in the notes to the financial statements.
Going Concern
13. An enterprise should not prepare its financial statements on a going concern basis if management determines after the balance sheet date either that it intends to liquidate the enterprise or to cease trading, or that it has no realistic alternative but to do so.
14. Deterioration in operating results and financial position after the balance sheet date may indicate a need to consider whether the going concern assumption is still appropriate. If the going concern assumption is no longer appropriate, the effect is so pervasive that this Standard requires a fundamental change in the basis of accounting, rather than an adjustment to the amounts recognized within the original basis of accounting.
15. IAS 1, Presentation of Financial Statements, requires certain disclosures if:
(a) the financial statements are not prepared on a going concern basis; or
(b) management is aware of material uncertainties related to events or conditions that may
cast significant doubt upon the enterprise’s ability to continue as a going concern.
The events or conditions requiring disclosure may arise after the balance sheet date.
Disclosure
Date of Authorization for Issue
16. An enterprise should disclose the date when the financial statements were authorized for issue and who gave that authorization. If the enterprise’s owners or others have the power to amend the financial statements after issuance, the enterprise should disclose that fact.
17. It is important for users to know when the financial statements were authorized for issue, as the financial statements do not reflect events after this date.
Updating Disclosure about Conditions at the Balance Sheet Date
18. If an enterprise receives information after the balance sheet date about conditions that existed at the balance sheet date, the enterprise should update disclosures that relate to these conditions, in the light of the new information.
19. In some cases, an enterprise needs to update the disclosures in its financial statements to reflect information received after the balance sheet date, even when the information does not affect the amounts that the enterprise recognizes in its financial statements. One example of the need to update disclosures is when evidence becomes available after the balance sheet date about a contingent liability that existed at the balance sheet date. In addition to considering whether it should now recognize a provision under IAS 37, Provisions, Contingent Liabilities and Contingent Assets, an enterprise updates its disclosures about the contingent liability in the light of that evidence.
Non-Adjusting Events After the Balance Sheet Date
20. Where non-adjusting events after the balance sheet date are of such importance that
non-disclosure would affect the ability of the users of the financial statements to make
proper evaluations and decisions, an enterprise should disclose the following information
for each significant category of non-adjusting event after the balance sheet date:
(a) the nature of the event; and
(b) an estimate of its financial effect, or a statement that such an estimate cannot be
made.
21. The following are examples of non-adjusting events after the balance sheet date
that may be of such importance that non-disclosure would affect the ability of the users
of the financial statements to make proper evaluations and decisions:
(a) a major business combination after the balance sheet date (IAS 22, Business
Combinations, requires specific disclosures in such cases) or disposing of a major
subsidiary;
(b) announcing a plan to discontinue an operation, disposing of assets or settling
liabilities attributable to a discontinuing operation or entering into binding agreements
to sell such assets or settle such liabilities (see IAS 35, Discontinuing Operations);
(c) major purchases and disposals of assets, or expropriation of major assets by
government;
(d) the destruction of a major production plant by a fire after the balance sheet
date;
(e) announcing, or commencing the implementation of, a major restructuring (see IAS 37,
Provisions, Contingent Liabilities and Contingent Assets);
(f) major ordinary share transactions and potential ordinary share transactions after the
balance sheet date (IAS 33, Earnings Per Share, encourages an enterprise to disclose a
description of such transactions, other than capitalization issues and share splits);
(g) abnormally large changes after the balance sheet date in asset prices or foreign
exchange rates;
(h) changes in tax rates or tax laws enacted or announced after the balance sheet date
that have a significant effect on current and deferred tax assets and liabilities (see IAS
12, Income Taxes);
(i) entering into significant commitments or contingent liabilities, for example, by
issuing significant guarantees; and
(j) commencing major litigation arising solely out of events that occurred after the
balance sheet date.
Effective Date
22. This International Accounting Standard becomes operative for annual financial statements covering periods beginning on or after 1 January 2000.
23. In 1998, IAS 37, Provisions, Contingent Liabilities and Contingent Assets, superseded the parts of IAS 10, Contingencies and Events Occurring After the Balance Sheet Date, that dealt with contingencies. This Standard supersedes the rest of that Standard.
Amendments to Existing IAS
This Standard amends existing International Accounting Standards as set out below. All deletions are shaded and struck through and all additions are shaded.
Updating of references to IAS 10
The following references to “IAS 10, Contingencies and Events Occurring After the
Balance Sheet Date” are replaced by references to “IAS 10, Events After the
Balance Sheet Date”:
· IAS 21, The Effects of Changes in Foreign Exchange Rates (paragraph 46);
· IAS 22 (revised 1998), Business Combinations (paragraph 97);
· IAS 33, Earnings Per Share (paragraph 45); and
· IAS 37, Provisions, Contingent Liabilities and Contingent Assets (paragraph 75).
The following references to “IAS 10, Contingencies and Events Occurring After the
Balance Sheet Date” are replaced by references to “IAS 37, Provisions,
Contingent Liabilities and Contingent Assets”:
· IAS 19, Employee Benefits (paragraph 35); and
· IAS 32, Financial Instruments: Disclosure and Presentation (paragraph 73).
In the following places, the terms “approval [of the financial statements]”
and “approved [the financial statements]” are replaced by the terms
“authorization [of the financial statements] for issue” and “authorized
[the financial statements] for issue”:
· IAS 1, Presentation of Financial Statements (paragraphs 63(c), 64 and 65(a));
· IAS 19, Employee Benefits (paragraph 20(b));
· IAS 22 (revised 1998), Business Combinations (paragraphs 30 and 31(c));
· IAS 35, Discontinuing Operations (paragraph 8 of the introduction and paragraph 4 of
appendix 2); and
· IAS 37 Provisions, Contingent Liabilities and Contingent Assets (appendix C, example
10)
IAS 1, Presentation of Financial Statements (paragraph 74(c))
(c) the amount of dividends that were proposed or declared after the balance sheet date
but before the financial statements were authorized for issue when dividends have been
proposed but not formally approved for payment, the amount included (or not included) in
liabilities;and;
IAS 2, Inventories (paragraph 28)
28. Estimates of net realizable value also take into consideration the purpose for which the inventory is held. For example, the net realizable value of the quantity of inventory held to satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, the net realizable value of the excess is based on general selling prices. Provisions or contingent liabilities may arise from Contingent losses on firm sales contracts in excess of inventory quantities held or from and contingent losses on firm purchase contracts. Such provisions or contingent liabilities are dealt with under IAS 37, Provisions, Contingent Liabilities and Contingent Asset in accordance with IAS 10, Contingencies and Events Occurring After the Balance Sheet Date.
IAS 11, Construction Contracts (paragraph 45)
45. An enterprise discloses any contingent liabilities and contingent assets gains and losses in accordance with International Accounting Standard IAS 10, Contingencies and Events Occurring After the Balance Sheet Date IAS 37, Provisions, Contingent Liabilities and Contingent Assets. Contingent liabilities and contingent assets gains and contingent losses may arise from such items as warranty costs, claims, penalties or possible losses.
IAS 12, Income Taxes (paragraph 88)
88. An enterprise discloses any tax-related contingent liabilities gains and contingent assets losses in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets IAS 10, Contingencies and Events Occurring After the Balance Sheet Date. Contingent liabilities gains and contingent assets losses may arise, for example, from unresolved disputes with the taxation authorities. Similarly, where changes in tax rates or tax laws are enacted or announced after the balance sheet date, an enterprise discloses any significant effect of those changes on its current and deferred tax assets and liabilities (see IAS 10, Events After the Balance Sheet Date).
IAS 18, Revenue (paragraph 36)
36. An enterprise discloses any contingent gains liabilities and contingent assets losses in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets IAS 10, Contingencies and Events Occurring After the Balance Sheet Date. Contingent gains liabilities and contingent assets losses may arise from items such as warranty costs, claims, penalties or possible losses.
IAS 19, Employee Benefits (paragraphs 125 and 141)
125. Where required by IAS 37, Provisions, Contingent Liabilities and Contingent Assets IAS 10, Contingencies and Events Occurring after the Balance Sheet Date, an enterprise discloses information about contingent liabilities contingencies arising from post-employment benefit obligations.
141. A contingency exists Where there is uncertainty about the number of employees who will accept an offer of termination benefits, a contingent liability exists. As required by IAS 37, Provisions, Contingent Liabilities and Contingent Assets IAS 10, Contingencies and Events Occurring After the Balance Sheet Date, an enterprise discloses information about the contingency contingent liability unless the possibility of a loss an outflow in settlement is remote.
IAS 20, Accounting for Government Grants and Disclosure of Government Assistance (paragraph 11)
11. Once a government grant is recognized, any related contingency would be contingent liability or contingent asset is treated in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets IAS 10, Contingencies and Events Occurring After the Balance Sheet Date
IAS 28, Accounting for Investments in Associates (paragraph 26)
26. In accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets
IAS 10, Contingencies and Events Occurring After the Balance Sheet Date, the investor
discloses:
(a) its share of the contingencies contingent liabilities and capital commitments of an
associate for which it is also contingently liable; and
(b) those contingencies contingent liabilities that arise because the investor is
severally liable for all the liabilities of the associate.
IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial
Institutions, (paragraphs 26, 27, 50 and 51)
26. A bank should disclose the following contingencies contingent liabilities and
commitments required by IAS 10, Contingencies and Events Occurring After the Balance Sheet
Date:
(a) the nature and amount of commitments to extend credit that are irrevocable because
they cannot be withdrawn at the discretion of the bank without the risk of incurring
significant penalty or expense; and
(b) the nature and amount of contingencies contingent liabilities and commitments arising
from off balance sheet items including those relating to:
(i) direct credit substitutes including general guarantees of indebtedness, bank
acceptance guarantees and standby letters of credit serving as financial guarantees for
loans and securities;
(ii) certain transaction-related contingencies contingent liabilities including
performance bonds, bid bonds, warranties and standby letters of credit related to
particular transactions;
(iii) short-term self-liquidating trade-related contingencies contingent liabilities
arising from the movement of goods, such as documentary credits where the underlying
shipment is used as security;
(iv) those sale and repurchase agreements not recognized in the balance sheet;
(v) interest and foreign exchange rate related items including swaps, options and futures;
and
(vi) other commitments, note issuance facilities and revolving underwriting facilities.
27. IAS 10, Contingencies and Events Occurring After the Balance Sheet Date, IAS 37, Provisions, Contingent Liabilities and Contingent Assets, deals generally with accounting for, and disclosure of, contingencies contingent liabilities. The Standard is of particular relevance to banks because banks often become engaged in many types of contingent liabilities contingencies and commitments, some revocable and others irrevocable, which are frequently significant in amount and substantially larger than those of other commercial enterprises.
50. Any amounts set aside in respect of for general banking risks, including future losses and other unforeseeable risks or contingencies in addition to those for which accrual must be made in accordance with IAS 10, Contingencies and Events Occurring After the Balance Sheet Date, should be separately disclosed as appropriations of retained earnings. Any credits resulting from the reduction of such amounts result in an increase in retained earnings and are should not be included in the determination of net profit or loss for the period.
51. Local circumstances or legislation may require or allow a bank to set aside amounts
for general banking risks, including future losses or other unforeseeable risks, in
addition to the charges for losses on loans and advances determined in accordance with
paragraph 45. A bank may also be required or allowed to set aside amounts for
contingencies in addition to those for which accrual is required by IAS 10, Contingencies
and Events Occurring After the Balance Sheet Date. Such amounts for general banking risks
and contingencies do not qualify for recognition as provisions under IAS 37, Provisions,
Contingent Liabilities and Contingent Assets. Therefore, a bank recognizes such amounts as
appropriations of retained earnings. These charges may result in This is necessary to
avoid the overstatement of liabilities, understatement of assets, or undisclosed accruals
and provisions and . They present the opportunity to distort net income and equity.
IAS 31, Financial Reporting of Interests in Joint Ventures (paragraph 45)
45. In accordance with IAS 10, Contingencies and Events Occurring After the Balance
Sheet Date, a A venturer should disclose the aggregate amount of the following
contingencies contingent liabilities, unless the probability of loss is remote, separately
from the amount of other contingent liabilities contingencies:
(a) any contingencies contingent liabilities that the venturer has incurred in relation to
its interests in joint ventures and its share in each of the contingent liabilities
contingencies which have been incurred jointly with other venturers;
(b) its share of the contingent liabilities contingencies of the joint ventures themselves
for which it is contingently liable; and
(c) those contingent liabilities contingencies that arise because the venturer is
contingently liable for the liabilities of the other venturers of a joint venture.
IAS 35, Discontinuing Operations (paragraphs 20, 21, 29, 30 and 32)
20. A discontinuing operation is a restructuring as that term is expected to be defined
in IAS 37, Provisions, Contingent Liabilities and Contingent Assets the forthcoming
Standard on provisions. That Standard will IAS 37 provides guidance for certain of the
requirements of this Standard, including:
(a) what constitutes a “detailed, formal plan for the discontinuance” as that
term is used in paragraph 16(b) of this Standard; and
(b) what constitutes an “announcement of the plan” as that term is used in
paragraph 16(b) of this Standard.
21. The Standard on provisions will IAS 37 defines when a provision should be recognized. and will address the circumstance in which In some cases, the event that obligates the enterprise occurs after the end of a financial reporting period but before the financial statements for that period have been authorized for issue approved by the board of directors. Paragraph 29 of this Standard would requires disclosures about a discontinuing operation in such cases a circumstance.
29. If an initial disclosure event occurs after the end of an enterprise’s financial reporting period but before the financial statements for that period are authorized for issue approved by the board of directors or similar governing body, those financial statements should include the disclosures specified in paragraph 27 for the period covered by those financial statements.
30. For example, the board of directors of an enterprise whose financial year ends 31 December 20x5 approves a plan for a discontinuing operation on 15 December 20x5 and announces that plan on 10 January 20x6. The board approves authorizes the financial statements for 20x5 for issue on 20 March 20x6. The financial statements for 20x5 include the disclosures required by paragraph 27.
32. The asset disposals, liability settlements, and binding sale agreements referred to in the preceding paragraph may occur concurrently with the initial disclosure event, or in the period in which the initial disclosure event occurs, or in a later period. In accordance with IAS 10, Contingencies and Events Occurring After the Balance Sheet Date, if some of the assets attributable to a discontinuing operation have actually been sold or are the subject of one or more binding sale agreements entered into after the financial year end but before the board approves the financial statements for issue, the financial statements include the disclosures required by paragraph 31 if non-disclosure would affect the ability of the users of the financial statements to make proper evaluations and decisions.