A report on financial instrument measurement regulation in Australia
This report provides analysis of financial instrument measurement regulation in Australia which governed by AASB 139 and application of this standard on Telstra Group. The first part of the report is aimed to recognise the difference between AASB 139 and IAS 39, implication of changes, current regulation and issues, views of interested parties, and future development for AASB 139. The second part will analyse Telstra's annual report for financial year 2006 and 2009 for financial instrument measurement during transition period and afterward based on standards.
AASB 139 is the first standard issued by Australian Accounting Standard Board to regulate about the recognition and measurement of financial instruments which adopted from IAS 39.
The contents of both standards are similar with only slight differences in AASB 139 in order to accommodate other Australian regulations and effective date of transition.
Many interesting parties try to challenge the fair value measurement concept in this standards
since it will not reflect the real economic condition.
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In the future, IAS 39 will be replaced by IFRS 9 and AASB 139 will be replaced by AASB 9 which will simplify the classifications of financial assets into those to be carried at amortised cost and those to be carried at fair value.
The findings for the second part indicate that:
Telstra has applied the standards and measurements correctly in both years 2006 and 2009 for its financial instruments.
In 2006, Telstra adjusted its financial instruments during the transition period by grouping the financial instruments into three periods as well as reinstating its balance sheet account in that transition period for comparability purpose from AGAAP to AASB 139.
In 2009, Telstra has fully adopted AASB 139 and anticipate for recent issues of accounting standards.
Measurement of financial instruments perhaps is still being the most debatable issues in the accounting practices because of different perspective among regulators in terms of unit measurement and objectivity. For this specific purpose, AASB (Australian Accounting Standard Board) has issued AASB 139 as the Australian equivalent of IAS 39 from IASB (International Accounting Standard Board). IAS 39 itself will be replaced with IFRS 9 by the end of 2010 (www.iasb.org, 2010; www.iasplus.com, 2010). AASB 139, as an Australian Equivalent International Financial Reporting Standard (AIFRS), is applicable to financial years beginning on or after 1 January 2005.
On the first part of discussion, there will be some issues discussed comprising about the reason of adoption, the differences between AASB 139 and IAS 9, implication of changes for Australian entities, complex issues in the current regulation, interested parties, and future developments about both standards. The issues discussed here are about recognition and de-recognition, measurement, impairment, derivatives, and hedge accounting.
For the second part, Telstra Group (hereafter is called Telstra) is picked as a company which implemented this regulation on its financial report relating to the fair value issue of derivative instruments and responded to the changes of the regulation consistently as shown on its annual report of 2006 and 2009.. Telstra is chosen because it is the leading telecommunication and information services company, with one of the best known brands and grouped as one of top 200 companies within Australia. The business operations of Telstra consisted of fixed line telephone, mobile phone, internet, and television services (www.telstra.com.au, 2010). Telstra has derivative financial instruments like forward exchange contracts, cross currency swaps and interest rate swaps to hedge risks associated with foreign currency and interest rate fluctuations (Telstra Annual Report, 2009).
Regulation of Financial Instrument Measurement
AASB 139, which regulate about Financial Instrument Measurement, is the Australian equivalent of IAS 39. Since it is merely an adoption, the contents are basically the same. The reason for the adoption is to reduce the cost of capital on foreign markets because of greater comparability. Moreover, the adoption will fill gaps in financial reporting in Australia, particularly for financial instruments issues (Drever et al., 2007).
Differences between AASB 139 and IAS 39
There some differences (additions and deletions) because of this adoption from IAS 39 to AASB 139. It needs to be adjusted with other Australian regulations which related to AASB 139 such as AASB 132 about Financial Instruments: Presentation and AASB 7 about Financial Instruments: Disclosures. Besides, AASB 139 is also tied up with Corporations Act 2001 particularly part 2M.3 about financial reporting and section 334 about accounting standards. The deletions from section 103 to 110 of IAS 39 are related to the Effective Date and Transition of AASB 139. The differences can be seen completely on Appendix 1.
Implications of Changes
Beforehand, there was no Australian Accounting Standard regulation about the recognition and measurement of financial instruments. Therefore, all the requirements firstly appeared on AASB 139 (www.treasury.act.gov.au, 2010). Since moving to AASB 139, there are some essential implications for entities regarding the measurement of financial instruments as follows (www.dtf.wa.gov.au, 2010):
Financial instruments/assets are required to be classified initially into one of five categories which will determine the accounting treatment;
According to paragraph 8-9, AASB 139 classifies the categories for financial instruments into four categories which consist of: Financial Assets at Fair Value through Profit and Loss; Held-to-Maturity Investments; Loans and Receivables; and Available-for-Sale Financial Assets. On Appendix 1, those categories are grouped more precisely into five categories. The difference is "Financial Assets at Fair Value through Profit and Loss" categorised into two: held for trading and non-trading liabilities.
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All derivatives must be recognised and measured at fair value regardless of use
Specific measurement rules apply for embedded derivatives; and
Strict rules apply for de-recognition and hedge accounting eligibility.
Current Regulation and Issues
AASB 139 is a practically difficult standard to apply and interpret since most of it is a 'rule standard'. It needs a lot of workings to adjust it to be more 'principle based' in order to make it easier to understand by users (www.moorestephensresources.com.au, 2010). Some complex areas discussed in AASB 139 are: recognition and de-recognition, measurement, impairment, derivatives, and hedge accounting.
Recognition and de-recognition
For initial recognition, a financial asset or liabilities is recognised when entities become a party to the instrument of contract (www.accaglobal.com, 2010). De-recognition of a financial assets occur when the contractual rights to the cash flows of the financial asset have expired or the financial asset has been transferred or sold. For de-recognition of a financial liability, it can be de-recognised only when it is extinguished (www.dtf.wa.gov.au, 2010).
Measurement is regulated in paragraph 43-49 of AASB 139. Both financial assets and financial liabilities are initially recognised at fair value. Subsequent measurement depends on how the financial measurement is categorised. It can be measured at amortise cost using the effective interest method or at fair value (www.archive.iasb.org.uk, 2010). Based on Appendix 2, amortised cost is used to measure: loan and receivables, held-to-maturity, and non-trading liabilities. While fair value is used for: held-for-trading and available-for-sale categories.
Financial assets carried at amortised cost and available-for-sale financial assets are potentially subject to impairment. AASB 139 impairment model can be described from Appendix 3.
Unlike primary financial instruments which only require straightforward accounting treatment, derivatives will lead to rights and obligations by transferring risks between parties to the derivative-related contract (Deegan, 2007). Some examples of derivatives are forwards, interest rate swaps, futures, and options and embedded derivatives.
Hedging is a risk management technique which aimed to offset changes in fair value or cash flows in order to avoid loss in the future. There are three types of hedging according to AASB 139: fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation.
Actually, a lot of industries that have interest in AASB 139 practices in their financial report. One of them is banking entities which argue that this standard will cause significant volatility in their accounts, particularly related to derivatives transactions. As a result, it will not reflect the real economic condition and probably will affect bank's financial stability. Therefore, they tried to lobby the local regulator to amend the requirement of IAS 39 as the source of adoption (Deegan, 2009).
Other party, for instance Pricewaterhouse Coopers, is also concern about fair value practices. The requirement to use fair value will provide inaccurate results as well as harm entities in the long run. Therefore, they suggest that fair value should be developed with the objective of providing information. Accordingly, it will serve the best interest of investors, business and regulators in the future (www.pwc.com, 2010; www. download.pwc.com, 2010).
In July 2009, IASB firstly issues exposure draft about Financial Instruments: Classification and Measurement and followed by issuing IFRS 9Â Financial Instruments which discussed about classification and measurement of financial assets. This is considered as the first phase to replace IAS 39. The second phase relates to impairment, for which an exposure draft is on issue, with the comment period closing June 2010. For the final phase, hedge accounting, an exposure draft is expected in the first quarter of 2010. Effective date of IFRS 9 will be in January 2013 with early adoption permitted starting in 2009 (www.iasplus.com, 2010; www.charteredaccountants.com.au, 2010).
In responding to those changes, the last development of AASB 139 was made in December 2009 by issuing AASB 9 about Financial Instruments. The new standard is available for early adoption for periods ending on or after 31 December 2009 and is required for application for periods beginning on or after 1 January 2013. It will replace the recognition and measurement requirements of financial assets of AASB 139. Essentially, AASB 9 will simplify the classifications of financial assets into those to be carried at amortised cost and those to be carried at fair value (www.charteredaccountants.com.au, 2010).
Application of AASB 139 by Telstra Group
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Annual Report 2006 (Appendix 4, note 2 & 36)
Because of changes in regulation regarding financial instruments measurement in Australia, in order to comply with AASB 139, Telstra separated the treatment for derivatives into three periods as follows:
First period is from 1 July 2004 to 30 June 2005 which applied by following AGAAP (Australian Generally Accepted Accounting Principles) within the scope of AASB 132 and AASB 139 under the exemption from AASB 1 (first adoption). Under AGAAP, the gain or loss arising from hedge activities is treated consistently with the gain or loss arising on the original hedged transaction or balance.
Adjustments were made at the transition date (1 July 2005) to restate the opening balance sheet (balance sheet reconciliation) in order to be consistent with AASB 132 and 139. The policy has changed by recognising financial instruments in balance sheet and recording all derivatives, including embedded derivatives at fair value. So that, adjustments to carrying amounts are taken to retained profits or reserves.
From 1 July 2005, derivatives are initially recognised at fair value on the date of contract and subsequently remeasured again to fair value. The remeasurement gain or loss depends whether the derivative is classified as hedging instrument or not. If not, the derivative will be categorised as 'held for trading' financial instruments.
Fair value of derivatives, some financial assets and liabilities are valued by reference to prices quoted in active markets, discounted cash flow analysis, fair value of recent arm's length transactions and option pricing models. The fair value of our forward exchange contracts by reference to forward exchange market rates for contracts with similar maturity profiles at the time of valuation.
Under previous AGAAP disclosures, derivative financial instruments were classified under other assets and other liabilities. For comparative purposes these amounts have been reclassified to derivative financial assets or liabilities on the balance sheet on transition to AIFRS (Appendix 4, Note 16 & 20)
Annual Report 2009 (Appendix 5, notes 2)
In 2009, Telstra has fully adopted AASB 139, 132 and 7 for its financial instruments consistently. Derivatives are still recognised at fair value at first and remeasured again to fair value afterwards. Fair value estimation is calculated the same with 2006 annual report after 1 July 2005 period above. However, there are some recent issues of accounting standards need to be applied in future reporting periods. One of them is AASB 2009-2 about Improving Disclosure about Financial Instruments which is applicable to Telstra from 1 July 2009. It requires enhanced disclosures about fair value measurements and liquidity risk and introduces a three level hierarchy for making fair value measurements. These impacts are being assessed by Telstra. Telstra also classified the financial assets based on four categories as required by AASB 139. For hedge accounting purposes, Telstra adopted three types of hedges from AASB 139 plus derivatives with no hedging relationship and embedded derivatives. From Annual Report 2009 Telstra has classified derivatives financial instruments based on AASB 139 (Appendix 5, Table C, note 17)
Based on the explanation above, it can be concluded that AASB 139 is the first standard issued by Australian Accounting Standard Board to regulate about the recognition and measurement of financial instruments which is applicable to financial years beginning on or after 1 January 2005. Since it is adopted from IAS 39, the contents are similar with only slight differences in order to accommodate other Australian regulations and effective date of transition. However, AASB 139 is a difficult standard to apply and interpret and needs a lot of workings to make it more 'principle based'. Consequently, this regulation also brings some implications for entities in Australia to group their financial instruments into four categories along with the measurements strictly. In fact, many interesting parties try to challenge the fair value measurement concept in this standard since it will not reflect the real economic condition and probably will affect stability, provide inaccurate results as well harm the entities in the long term. In the future, IAS 39 will be replaced by IFRS 9 with effective date in January 2013 with early adoption permitted starting in 2009. Responding to that, AASB 139 will be replaced by AASB 9 and required for application for periods beginning on or after 1 January 2013. It will simplify the classifications of financial assets into those to be carried at amortised cost and those to be carried at fair value.
After comparing Telstra annual report 2006 and 2009 (Appendix 4 & 5), it can be concluded that Telstra has applied the standards and measurements correctly in both years. In 2006, Telstra adjusted its financial instruments during the transition period by grouping the financial instruments into three periods as well as reinstating its balance sheet account in that transition period for comparability purpose from AGAAP to AASB 139. As consequences, adjustments to carrying amounts are made to retained profits or reserves. In 2009, Telstra has fully followed AASB 139 and anticipate for recent issues of accounting standards.
Appendix 1. Differences between AASB 139 and IAS 39
Appendix 2. Categories for financial instruments
Appendix 3. AASB 139 Impairment Model
Appendix 4. Telstra Annual Report 2006
Appendix 5. Telstra Annual Report 2009
Differences between AASB 139 and IAS 39 (www.chareteredaccountants.com. au, 2010):
Additions (begins with prefix Aus)
Standard applies to reporting entities and general purpose financial reports
The application date begins since annual reporting period 1 January 2005
Prohibition to apply before annual reporting period 1 January 2005
Requirements are subject to AASB 1031 about Materiality
The date of publication is 22 July 2004
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