Many commentators have suggested that the current approach to the fair value measurement of financial instruments has had a destabilising effect on some entities. Furthermore, a significant number of commentators have raised concerns that financial statements under the existing standards do not provide enough transparency, particularly when it comes to complex financial instruments and fair values. As a consequence the International Accounting Standards Board (IASB) is taking a number of steps to address the accounting requirements for financial instruments.
Improving financial instrument disclosures
'Improving disclosures about financial instruments – amendments to IFRS 7 Financial Instruments: Disclosures' has been issued in response to the concerns about transparency of financial instrument disclosures. The main aim of the amendments is to enable the user of financial statements to have a better understanding of the measurements and judgements that underpin the fair values of financial instruments in the accounts.
The revised version of IFRS 7 will require entities to analyse their financial instruments held at fair value across a three level hierarchy.
- Level 1 – fair values are measured using quoted prices.
- Level 2 – fair values are measured using inputs that are derived from observable market data.
- Level 3 – fair values are measured using inputs that are not based on observable market data.
Instruments will be categorised based on the lowest level of input that is significant to their fair value.
The entity will also have to disclose how the financial instruments in the statement of financial position (the new term for balance sheet) are spread across the three levels and give information about the fair value gains and losses that relate to each of those levels.
The amendments also affect the disclosure of liquidity risk. There are new rules clarifying how, and if, derivatives should be disclosed as part of the contractual maturity analysis already required by the standard. In addition, there are required disclosures about any uncertainties in the timing or amount of cash flows shown in the contractual maturity analysis. Also, under the revised standard, entities should provide, where appropriate, a maturity analysis for financial assets that are used to manage liquidity risk.
The effective date of these amendments is for annual periods beginning on or after 1 January 2009. In the first year of application, comparative disclosures will not be required.
Smith & Williamson commentary
For many IFRS preparers, the amendments to IFRS 7 will not result in a significant increase in disclosure. However, for those IFRS preparers who hold a number of different financial instruments at fair value, implementation of the revised standard will not be straightforward. Entities will need to group their financial instruments in a new way and then provide disclosures on this basis. Despite the initial exemption for comparative figures, preparers who have a large number of financial instruments may find that their accounting systems do not readily provide the new information.
A new standard for financial instruments – IFRS 9
In the summer the IASB launched a major new project that will result in the eventual replacement of IAS 39. The project represents a complete overhaul of the existing standard, and the IASB is aiming to develop a simpler and more transparent approach to financial instrument accounting.
The IASB has confirmed that the changes resulting from this project will not be mandatorily effective before January 2013. However, at the time of going to print the first phase of the project had just completed. IFRS 9 'Financial instruments' deals with classification and measurement. The new standard is available for early adoption for December 2009 year-end financial statements, leaving a very limited period of preparation for any entities that wish to do so. We will return to this new standard in our next edition of Financial reporting
Smith & Williamson commentary
Any simplification of financial instrument accounting is more than welcome. However, due process and consideration is vital to successful standard setting particularly in such a complex area. Whether a standard that is produced under such a short timetable addresses all of the issues preparers face can only be judged with time. There exists however a real possibility of subsequent revisions and additional guidance as the principles begin to be applied in practice. In the circumstances, any entity considering early adoption of the classification and measurement standard should think carefully before proceeding.
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