IAS 39 – Would the proposed improvements meet expectations?

The International Accounting Standards Board (IASB) last week issued the exposure draft on classification and measurement of financial instruments, as part of the project to improve International Accounting Standard No 39 (IAS 39), which governs the accounting treatment of financial instruments.

The complexity of accounting for financial instruments with different classification categories and impairment methods has been associated with the financial crisis by some governments in the G20.

In responding to recommendations made by the G-20 and the Financial Stability Board, IASB has come up with a three-stage programme to address concerns around IAS 39. The first part of the programme is the simplification of classification and measurement basis as proposed by this exposure draft. Exposure draft on Impairment Methodology is expected to be issued in October and the one on Hedge Accounting should be available in December.

IASB intends to cap the measurement basis of financial instruments into two categories — amortised cost and fair value. A financial instrument would be accounted using the amortised cost if it meets two criteria.

First is whether it has a basic loan feature, contractual terms that give rise to cash flows from payments of principal and interest on the principal outstanding.

Second is whether it is managed on a contractual yield basis — this is whether the business model is to pay and receive contractual cash flows that are generated when held or issued.

Financial instruments which do not meet the criteria to use the amortised cost method would be accounted for using fair value method.

The exposure draft also retains the fair value option that permits an entity to elect at initial recognition to measure any financial asset or liability at fair value through profit and loss if such designation eliminates or significantly reduces a measurement or recognition inconsistency.

Another interesting proposal is the requirement for all investment in equity instruments (and derivatives in those equity instruments) to be measured on fair value. The exemption on not quoted equity has been taken away.

Given the IASB has used decision-usefulness as the overriding principle in taking away the exemption, it recognises that there would be additional cost to preparers but the IASB feels this is outweighed by the benefits to users of financial statements.

The decision to do away with the exemption would certainly bring more companies within the ambit of the standards.

Given that IAS 39 has always been cited as a complicated standard to implement, we in Malaysia should take this opportunity to be involved in the improvements of the standard.

It would be great for sectors which are affected by the standard such as the financial services and companies with huge investment portfolios to identify issues that may be brought by the improved IAS 39 and proposed solutions to IASB.

While the concept appears to reduce some difficulties in the past, the test is always at the implementation stage of the standard. Who else would be in the best position to provide feedback if not those that would have to apply it?

As of today, IAS 39 has been issued in Malaysia and named FRS 139. It would be effective on Jan 1, 2010. Another question that may need to be answered is whether we will apply the “improved IAS 39” next year or implement the existing FRS 139? By applying the improved standards, the benefits would be experienced immediately. However, past experience suggests that there is merit to observe how the standard fares in other jurisdictions before we pick it up here.

We could be in a better position to decide which way to go once the other instalments of the improvements as mentioned earlier are exposed and decided upon.

Given that Malaysia has decided to converge with the IFRS by 2012, we should also learn to move at par with the world. Therefore, it is very important for us to view proposed changes to the standards differently from how we used to treat them in the past.

Perhaps audit committees should include developments of accounting standards as a fixed agenda as there would be higher frequency of changes and developments, moving forward.

This would ensure the implications and implementation issues are identified and appropriate actions are taken to ensure the financial reporting quality is maintained. This includes ensuring continuous training among the financial reporting team and improvements in the accounting system to cater to the changing standards and reporting requirements.

We have a clear opportunity to shape one of the challenging accounting standards by providing our views and feedback on the exposure draft on IAS 39.

While some may prefer to remain on the side and criticise, those who decide to be involved seriously would be the ones who would make the difference. Which group do you think you are in?

The article was also published in the Financialdaily which could be read here: 
http://www.theedgemalaysia.com/commentary/129178-ias-39--would-the-proposed-improvements-meet-expectations.html