Literature Seminar on Financial Reporting


Literature Seminar on Financial Reporting

The IASB's proposal to revise the classification and measurement of financial instruments


During the financial crisis, the International Accounting Standards Board (IASB), standard setter for international accounting regulation, has been under pressure to revise their standard for the accounting of financial instruments. As a reaction, the IASB has published in July 2009 an exposure draft outlining their proposal to revise IAS 39 Financial Instruments: Classification and Measurement initiating an intense debate. This paper serves to examine the IASB's proposal with respect to the old IAS 39. First, it will give an oultine of the former IAS 39, then discuss the exposure draft, and then present the new IFRS 9. In the end a conclusion will be given summarising and evaluating the extent to which IFRS 9 has fulfilled the IASB's proclaimed aims.

List of Abbreviations


AfS Available-for-Sale

ED Exposure Draft

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FI Financial Instrument

FV Fair Value

FVO Fair Value Option

HtM Held-to-Maturity

HfT Held-for-Trading

IAS International Accounting Standard

IASB International Accounting Standard Board

IFRS International Financial Reporting Standard

1. Introduction

1.1 Thesis Motivation

As a consequence of the financial crisis, international accounting standards have been in the focus of attention. Resulting from the belief, FV accounting with its pro-cyclic effects might have further exacerbated the financial melt-down (European Commission Director General, 2009), caused the deterioration of banks' equity and catalysed a wave of bankruptcies (Khan, 2009), the accounting community came up with suggestions for improvement. In this context IAS 39 which also deals with the recognition and measurement of financial instruments (FIs) is currently in the process of revision (IASB, 2009a). This paper will discuss issues of former IAS 39, give an outline of the discussion that lead to IFRS 9, and finally reflect on the new standard.

The revised standard's proclaimed aim is to reduce the level of complexity that is currently criticised by practitioners and is meant to ultimately replace the old standard as a new IFRS 9 (IASB, 2009b). Hence, an open discussion conducted in three phases has been initiated by the standard-setting International Accounting Standards Board (IASB). Phase one deals with the recognition and measurement of FIs, phase two covers issues of impairment methodology and phase three discusses hedge accounting principles[1].

This paper will examine the IAS 39 revision of phase one, meaning the classification and measurement of FIs, because this part has been met by the most severe criticism and has the most recent implications for practitioners. In particular, the extent to which IFRS 9 solves the problems made evident during the financial crisis shall be assessed.

1.2 Background

The IASB has published an exposure draft (ED) in July 2009 - ED/2009/7, Financial Instruments: Classification and Measurement (IASB, 2009b) - and has presented a final version in November 2009 to allow for voluntary application in 2009 - IASB: IFRS 9 Financial Instruments (IASB, 2009c). However, IFRS 9 has been refused to endorse by the European Financial Reporting Advisory Board (EFRAG) in accordance with the European Commission due to concerns raised over the "right balance on fair value (FV) accounting and possible impact on financial stability" (EFRAG, 2009a). A respective ED for phase two (Impairment methodology) has been published in November 2009 - ED/2009/12, Financial Instruments: Amortised Cost and Impairment (IASB, 2009j). An ED for phase three (Hedge accounting) will be published in December 2009. Since the publication of ED/2009/12 in June 2009, the IASB has met a number of times to discuss arguments and comments received by the public, and has then published a final standard of phase one in the form of IFRS 9 Financial Instruments on 12 November 2009. A compulsory application of the entire new standard is aimed to come into effect for financial statements from 2012 onwards. This paper will only deal with the revised accounting standards for the classification and measurement of FIs as of the above-mentioned reasons.

1.3 Issues

With the new standard, the IASB aims to reduce the complexity of IAS 39 and make it easier to understand because especially during the financial crisis, voices have been raised calling for a less strict application of FV accounting for assets without quoted market price (Khan, 2009). Hence, the new standard should simplify accounting application and allow for greater transparency about classification and measurements of FIs to the users of financial statements.

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In order to achieve this, the IASB has identified two major fields of IAS 39 to be revised that shall be assessed within the scope of this paper, namely: (1) measurement at FV, or (2) measurement at amortised cost. Within these two fields, a number of sub-topics were developed throughout the discussion period. These comprised detailed classification standards for different FIs, namely financial assets and financial liabilities. FIs that only possess basic loan features and are managed on contractual cash flow terms would be measured at amortised cost while all other FIs would be measured at their FV (IASB, 2009b). As this method would basically simplify measurement methods along the two approaches fair value or amortised cost, all other existing categories such as loans and receivables, held-to-maturity (HtM) investments or available-for-sale (AfS) assets would be abolished. Hence the former multi-category approach would be replaced by a strict two-category solution.

In order to deal with current complex accounting requirements imposed by the old IAS 39, the IASB further decided to review for test purposes the following aspects in a way that would enhance simplicity and transparency (IASB, 2009d). Firstly, financial hybrid contracts whose host contract is within the scope of IAS 39 would be recognised as one single unit. This means that the hybrid contract would not be separated from any embedded derivative as was previously the case. Therefore, the contract would be recognised at amortised cost if the embedded derivative holds basic loan features. Such basic loan features could be caps, floors or collar structures that might change interest rates of the contract or alike. Secondly, investments in structured vehicles with waterfall features[2] would be accounted for as outlined in application guidelines (IFRS 9.B4.20 et seq.). Thirdly, in case a hybrid contract does not qualify in terms of IAS 39, the contract would be accounted for at existing requirements for embedded derivatives (IFRS 9.4.8). Fourthly, a FV option (FVO) would be kept allowing entities to recognise FIs at FV - although they would technically-speaking require a measurement at amortised cost - if a measurement at amortised cost would prevent or reduce measurement or recognition inconsistency. This would finally address what is commonly known as accounting mismatch, meaning the non-compliance of change in equity and income statement. Lastly, entities would be allowed to show FV changes for equity instruments in other comprehensive income (OCI), excluding HfT instruments. Consequently, a second impairment testing would prove redundant as the amounts recognised in OCI were not to recur in profit or loss at disposal or at any other point in time. Furthermore, the new IAS 39 would require entities to choose a presentation mode at initial inclusion into the financial statements for a holding's entire retention time. Dividend payments of such instruments would correspondingly also be booked in OCI without recycling them through profit or loss.

The final version of phase one has been published 12 November 2009 but endorsement by the regulator has been refused so far (EFRAG, 2009b). In the following this paper will give an overview over the major points of discussion and major changes before evaluating the new standard in the end.

2. The former IAS 39

The former IAS 39 required all financial assets and liabilities including all derivatives and embedded derivatives to be recorded on the balance sheet[3] (IASB, 2009e). In the following paragraphs the - for this paper relevant - inclusion, recognition and subsequent measurement of FIs under old IAS 39 shall be outlined.

For the purpose of subsequent measurement, FIs were classified in one of the following four categories (see IAS 39.45 in conjunction with IAS 39.9[4]): loans and receivables, HtM investments, financial assets at fair value through profit or loss, or AfS financial assets. On the liability side, there were no particularly assigned categories. As long as these liabilities were not recognised through profit or loss at their FV (IAS 39.47), they were strictly recognised at amortised cost[5].

2.1 Initial Inclusion into Financial Statements

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Generally, FIs need to be included into the annual balance sheet when the reporting entity acted as a party to a contract on FIs (IAS 39.14) which also remains valid for the new IFRS 9. For the purchase under normal market conditions there used to be the option for the recognition of FIs on trade date or on settlement date. Correspondingly, the once chosen method had to be applied consistently for every category of financial assets in the terms of IAS 39.9 (see IAS 39.38 and .AG53-.AG56) which means a later reclassification of the asset into another category was excluded. Figure 1 describes the different accounting directives for either trade date or settlement date accounting[6].

2.2 Recognition

At first inclusion into the financial statement all FIs had to be recognised at their FV (IAS 39.43). A FV represents the amount at which contractual and independent counterparties can swap an asset or settle a liability (IAS 39.9). Hence, under normal conditions the FV always corresponded to the current market price. Should such market price not exist, values needed to be derived from transactions on comparable markets or calculated using generally-accepted valuation models[7]. At the point of recognition the FV generally represented the transaction price[8]. Henceforth, directly accountable transaction cost needed not be considered as long as they did not concern FIs recognised through profit or loss at their settled time value (IAS 39.43). Otherwise, should these instruments have an effect on profit or loss, they would have had to be subject to impairment.

2.3 Subsequent Measurement

The recognition of financial assets is depicted in Figure 2. It shall be outlined in the following as it is necessary to comprehend when looking at IFRS 9.

The category for HtM investments contained non-derivative financial assets with fixed or determinable payments and a fixed maturity for which a holding intention and ability existed (IAS 39.9). At initial inclusion, these could be optionally recognised at their FV or classified as AfS assets[9]. In case of a disposal of one or more non-fundamental part of a financial asset, this asset would not anymore classify as HtM investment (referred to as the "tainting rule"[10]).

The category loans and receivables contained given and acquired loans and receivables (IAS 39.9) and was restricted to FIs with fixed or determinable payments that were not listed on any active market[11]. Alternatively, financial assets fulfilling the criteria of being listed on an active market could be designated or classified as AfS assets at initial inclusion into the financial statements at their FV[12].

The category financial assets recognized through profit or loss at amortised cost was subdivided into two categories (IAS 39.9): (1) Held-for-trading (HfT) financial assets, and (2) Financial assets that are qualified at initial inclusion at their FV (Fair value option (FVO)), whereby equity instruments without a price on an active market were not allowed to be designated to this category if their FV could not be reliably measured. FIs were classified as HfT assets if they were either held with the purpose of a resale in the near future, if they were part of a portfolio of unambiguously identified and jointly-managed FIs for which there were clear indications of profit-taking in the past, or if they clearly classified as derivative securities. FIs could be designated using the FVO if this allowed for more relevant information to be revealed due to the abatement or significant reduction of valuation-attributable accounting mismatches otherwise arising through valuation directives for assets and liabilities or through different inclusion of profit and loss[13]. They could also be classified under the FVO if these instruments were managed at a FV basis and if their performance were measured on this basis. Should a contract contain one or more embedded derivatives, designation of this contract under the FVO was possible unless the embedded derivative had only little impact on cash flows of the underlying contract or its separate accounting was not allowed[14]. For contracts without clearly ascertainable FV of a financial derivative with obligation to bifurcate, designation of the entire contract under the FVO was compulsory.

If desired, all financial assets could also be allocated to the category AfS assets at one's own discretion (with the exception of trading assets). However, in case financial assets could not be recognised through any other category, recognition through AfS assets was compulsory[15]. Corrections of the attached FV of assets available for sale - independent of the nature of impairment (gains or losses) - generally needed to be designated without effect on profit or loss in revaluation surplus[16]. Should financial assets of this category be charged to expenses, previously directly in equity accounted profits needed be reclassified into the income statement.

2.4 Reclassification

IAS 39 provided a number of directives concerning the reclassification of FIs into different categories that used to be defined within IAS 39.50-.54 and is depicted in Figure 3. If an entity chose not to dispose or redeem financial assets in the short term, reclassification of this asset into the category FIs at amortised cost (trading) was allowed given accordance with IAS 39.50B or .50D. Furthermore, a reclassification of AfS assets under certain conditions was allowed (IAS 39.50E).

A reclassification of financial assets in loans and receivables after initial inclusion into the financial statements as well as reclassifications of financial liabilities were prohibited. Given there was no further intent of short-term disposal or redemption, financial assets recognised at FV through profit or loss were permitted to reclassification under one of the following conditions: (1) there were extraordinary events (IAS 39.50B), or (2) the financial asset complied with the definition of loans and receivables at reclassification and the entity intended and was capable of holding it for a foreseeable period (IAS 39.50D)[17]. In the same respect, AfS financial assets could also be classified under loans and receivables if they fulfilled the definition of loans and receivables at reclassification and the entity was able and had the intention of holding the asset for a foreseeable time or until maturity.

On the other hand, AfS financial assets could also be reclassified as HtM financial investments as long as intention and capability to hold the asset until maturity was given or the retention period for classification of HtM investments had expired[18]. The FV at the moment of reclassification represented amortised cost (IAS 39.50F). Profit and loss held in revaluation surplus required distribution over remaining time to maturity using effective interest method with fixed-maturity financial assets and continuance in revaluation surplus until disposal of financial assets without fixed maturity. HtM investments had to be reclassified as AfS assets and be measured at amortised cost if intention or ability to hold the asset until maturity changed (IAS 39.51). Disposals or reclassifications of FIs of significant value in this category caused a reclassification of all HtM investments into AfS assets and to respective measurement at amortised cost (IAS 39.52 in conjunction with IAS 39.9). After a significant reclassification in this category, a new reclassification into HtM investments was not allowed for the subsequent two business years (IAS 39.9). Due to the number of complex regulation guidelines, reclassification in particular was in the centre of critics who complained about the complexity of IAS 39.

3. The IASB's Proposal to revise IAS 39

During the financial crisis, accounting standards and particularly IAS 39 has been harshly criticised due to a number of reasons. The IASB was under pressure from governments[19] and international bodies (Group of Twenty (G20), 2009) as banks were in deep crisis and a number of large institutions were bailed out with government money as they had to write off on assets that were subject to FV accounting. Since the market for some instruments[20] failed to exist, financial assets without quoted market price had to be valued at zero (Classifying instruments as HfT - rather than as HtM or loans and receivables - urged financial institutions to recognise them at FV through profit or loss, which translated into significant latent losses due to the deterioration of credit and US real estate markets). These pro-cyclic write-offs have burdened the budgets of many institutions and have aggravated the financial crisis (Trussel & Rose, 2009).

Therefore, the IAS made short term adjustments to IAS 39, facilitating the reclassification into categories such as HtM. Furthermore, in order to address the issue of complexity in understanding, application and interpretation, the IASB has made a number of proposals to revise the standard. In this respect, it has initiated discussions in an exposure draft (IASB, 2009b) and called for open discussion on the issue.

In its ED/2009/7, the IASB pointed out the following issues to be revised: Classification, accounting for embedded derivatives, FVO, reclassification, investments in equity without quoted market price and whose value cannot be reliably measured, investments in equity instruments measured at FV through OCI, and effective date. In the following, the major discussion points, and their results shall be outlined.

3.1 Classification Approach

IAS 39 was commonly criticised due to its high complexity caused by the high number of classification categories for FIs with each sustaining its own rules for in- or exclusion of instruments into financial statements and requirements for asset impairment testing. Discussion papers and their responses indicated that it would be considered easier if FIs with high variable cash flows or instruments that were part of trading operations were differentiated from those instruments that possessed a principal amount, were held for purposes of collection or payment of contractual cash flows, and which are not meant to be disposed of to or settled with a third counterparty (IASB, 2009b). In addition, it was argued that introducing such differentiation the information quality of financial statements in respect to former IAS 39 could be enhanced (IASB, 2009f). Hence, the IASB based classification on two criteria: on (1) how an entity manages its FIs (i.e. its business model), and on (2) the contractual terms of the instrument (i.e. its cash flow characteristics). This has been the result because according to general perception the general objective of an entity was to hold FI in order to service contractual cash flows rather than to realise FV changes by early disposal. Therefore it was argued, entities should not have to recognise all FV changes in their financial statement, depending on the business model. By applying a classification based on an entity's business model and on contractual cash flow characteristics, the IASB aimed to receive the most informative presentation of FIs. Hence, instruments with informative current value would have to be measured at FV and instruments with informative contractual cash flows would be measured at amortised cost according to the IFRS 9 (IASB, 2009c). Although this approach has been widely accepted, some critics argued that a strict measurement at FV for all FIs would give a more realistic view on an entity's realistic condition (Committee on Capital Markets Regulation, 2009). Other critics supported a measurement for which amortised cost would only be used once the instrument's FV cannot be reliably measured or proves impracticable[21] or when the FV would represent the instrument's default (IASB, 2009f). In order to address these critics, the IASB modified its view in the new IFRS 9 whereby the classification of financial liabilities was exempted and would be specified differently.

For the classification of hybrid contracts, the IASB suggested not to require separation of embedded derivatives from their hybrid financial host contracts anymore in order to achieve a significant reduction of complexity (IASB, 2009c). However, this proposal has provoked a lot of high-ranking critics who rather support an application of IAS 39 for the time being (EFRAG, 2009a). Opponents fear that due to the characteristics of contracts with embedded derivatives, more assets would have to be measured at fair value[22]  which would result in companies being subject to increased own credit risk[23] (EFRAG, 2009a). Hence, the IASB has reacted to these arguments by postponing revision of liability accounting to a later date (IASB, 2009g). Consequently, the new standard only includes measurement and classification of financial assets[24]. In addition, some critics argued that the proposed directive would be more difficult to understand and retain important information from the investors[25] (Conseil National de la Comptabilité, 2009). By treating a hybrid contract as a single accounting group that would have to be designated along the aforementioned criteria, the IASB aims to remove previously complicated and arbitrary directives within the scope of IAS 39. Critics have long found fault in the rule-based guidelines within IAS 39 as this has lead to an arbitrary application that diluted information and comparison quality of financial statements (Wadewitz, 2009). In this respect, accounting for embedded derivatives would occur within a single valuation unit either at FV through profit or loss or at amortised cost (IASB, 2009h).

Concerning a revision of the previous FVO, the IASB has suggested the implementation of an irrevocable option to discount financial assets at FV through profit or loss if this prevents or minimises the previously discussed accounting mismatch. At initial recognition, the FVO may also be applied for financial liabilities[26] (IASB, 2009e). Furthermore, the new standard would also allow entities to measure financial asset at amortised cost should the entity have previously sold other assets measured at amortised cost before maturity. This would eliminate the tainting rule which forced entities to reclassify an asset at its FV through profit or loss that was previously classified as HtM in case more than an insignificant amount of the financial asset was sold prior to maturity (IASB, 2009b). Nevertheless an entity would be required to separately present gains or losses from derecognition of financial assets or liabilities measured at amortised cost in OCI. A reclassification would in principle not be allowed in the new IFRS 9 (IASB, 2009b). This has upset many critics, particularly from the financial industry. They fear that the elimination of recycling through profit or loss would not allow them to show impairment gains from FV changes in profit or loss which would be prevented should recycling at derecognition be allowed (European Banking Federation (EBF), 2009). According to the IASB, recycling, however, remains prohibited as this would necessitate an impairment method in the standard, thus increasing the standards complexity. It would, nonetheless, be required should an entity change its business model and objectives in a way that has significant impact on the entity's operation and is demonstrable to external parties[27] (IASB, 2009c). Although a revision of IAS 39's reclassification regulations is sought after, many critics would prefer a reclassification directive that defines its approach along management's intention for the FI's use (GASB, 2009a). On the other hand, other voices have been raised, calling for a strict reclassification directive based on an entity's business model (No author, 2009).

3.2 Measurement Approach

In general, a new standard would require all investments in equity instruments to be measured at FV with gains and losses on impairment to be recognised through profit or loss. However, there are some exceptions: an entity would not be allowed on initial recognition to choose to present all FV changes from an investment in equity investment that is not held for trading to be recognised in OCI (IASB, 2009d), whereby the once chosen mode is irrevocably fixed for the investment's life cycle[28]. In contrast to the in the ED/2009/7 specified decision, in the new IFRS 9 dividends on such investments that were booked in OCI, would be recognised through profit or loss[29] (IASB, 2009c). Should there not be a quote on any active market for an equity instrument or in case that for a related derivate a value cannot be reliably measured, the instrument would still have to be measured at FV[30]. Nevertheless, the standard setter acknowledges that amortised cost may display an appropriate estimate of FV under limited conditions (IASB, 2009f). Previously, financial assets were initially valued at FV including transaction cost (IASB, 2009e). The directives in IAS 39 concerning impairments of financial assets and hedge accounting remain applicable (IASB, 2009g) as they will be dealt with at a later stage (IASB, 2009j).

The IASB has also suggested that financial assets be only measured along the two categories FV or amortised cost (IASB, 2009b). This was chosen in order to ensure a more informative and comparable presentation of financial assets for investors. Users of financial statements have often criticised the wide variety in different measurement categories, arguing it would complicate interpretation of presented results. Yet, in the new IFRS 9 many critics fear that due to the revised standard a greater or smaller share of financial assets would need to be measured at FV than was previously required by IAS 39. However, if an entity should have to apply FV to more or fewer financial assets of a portfolio depends on the type of business model and FI (IASB, 2009c). Many experts fear that such accounting would result in a lower involvement in equity instruments but favour fixed income investments as these would, unlike equity instruments, generally be recognised at amortised cost (Gilgenberg, 2009). Insurance companies[31] would henceforth have to recognise more assets at amortised cost, as they can recognise FIs at amortised cost that were previously categorised in AfS[32] (Zapp, 2009). Consequently, insurance companies can avoid impairments on their equity holdings that are not HfT which would conserve their equity ratio. On the other hand, others claim, the revised standard would support a higher equity ratio in portfolios, particularly in those from insurance companies (Börsen-Zeitung, 2009a). These contrary positions highlight the great uncertainty and diverging opinions attached to this subject. Therefore, critics and regulators have also criticised that there would have to be more time for the revision of the standard in order to fully comprehend potential impacts (Börsen-Zeitung, 2009b). Overall it can be expected that the more risk an entity attributes to its financial assets in terms of assets available for sale or held for trading purposes, the more assets will likely be measured at FV (i.e. an instrument's risk usually exalts with the nature of the instrument; the more equity oriented, the more risky is the asset (Post, Gründl, Schmidt, & Dorfman, 2007). Thus, instruments with basic loan features (thus less risk) would be measured at amortised cost). However, restrictions that existed previously in IAS 39 for some HtM investments and available for sales assets that did not allow many financial assets to be measured at amortised cost[33] would be eliminated in the new standard. On the other hand, the IASB proposed requirements that if FIs show basic loan features and if they are managed on a contractual yield basis, they need to be measured at amortised cost (see Classification approach). Amortised cost in this context should on the one hand provide users of financial statements with a more accurate view on the true value of the asset as this measurement reflects the anticipated cash flows that will result from the FI in the future. However, should an instrument be held with the intention of collecting cash flows through disposal and ensuing impairment gains, measurement at amortised cost does not truly reflect the assets value[34] as this would hide information from financial statements' users. Still the measurement conditions had been responded to with general agreement (EFRAG, 2009a).

Despite this, the previously in the ED/2009/7 published version caused a wave of critics, outlining that descriptions in the draft had not been sufficiently clear (GASB, 2009a). Furthermore, contractual cash flow characteristics of a financial asset serve as important factors for the determination of amortised cost as a reliable information provider for predicting probable future cash flows[35]. Nonetheless, measurement at amortised cost might not feasible for instruments: without initial cost, with a wide range of possible cash flow outcomes, or without contractual cash flows[36]. Henceforth, the new standard would position the recognition under the business model condition prior to the assessment of the contract type[37] which should be easier as en entity only needs to assess the contractual terms of the subset those assets that are managed under the contractual cash flow basis (IASB, 2009f). Consequently, in the new IFRS 9, the business model is described as the entity's objective to hold financial assets for the collection of contractual cash flows rather than to sell them before contractual maturity in order to realise FV changes (IFRS 9.B4.1 et seq.) whereby an asset would possess contractual cash flow characteristics if it yields a principal amount and interest with the interest including consideration for credit risk of the instrument and time value of money.

4. The new IFRS 9

Although the IASB has published IFRS 9 - the standard to replace IAS 39 (Financial Instruments: Classification and Measurement) - on 12 November 2009, a number of international regulatory bodies have denied acceptance of the standard to their generally accounting principles due to a number of reasons (Conseil National de la Comptabilité, 2009). Still there are also a number of institutions who do either not take position (Institut der Wirtschaftsprüfer, 2009), or actively promote the development of IFRS 9 into a piece of European legislature which is prevalent in German regulatory circles (GASB, 2009b). In the following, IFRS 9 shall be briefly outlined with regard to its predecessor directive IAS 39.

Overall IFRS 9 Classification and Measurement contains the following major changes:

  • Classification and measurement categories have been reduced to only two
  • The tainting rule has been abolished
  • Financial asset host contracts with embedded derivatives do not have to be separated
  • Impairment measures have been summarised under one single method for all financial assets[38]

The aforementioned changes apply for accounting of financial assets - excluding financial liabilities from IFRS 9 so far. The new standard also provides directives on the method of application for measurement at amortised cost (IFRS 9.B4.1 et seq.). However, the IFRS 9 also requires profound analysis of investments in contractually linked instruments that effect concentrations of credit risk[39] (IFRS 9.B4.17). In future (Unless a FVO is chosen), financial assets that were acquired on a secondary market or over-the-counter (OTC) need be measured at amortised cost, should the instrument be managed within an entity's business model with an objective to collect contractual cash flows, and should the asset only have contractual cash flows[40] (IFRS 9.B5.12).

When displaying gains or losses on equity instruments from changes in FV, an entity can no longer present all impairments in OCI but will prospectively be required to recognise dividends through profit or loss[41]. Reclassifications from amortised cost to FV accounting or vice versa will only be allowed if an entity should change its business model (IFRS 9.4.9). However, since an entity can have different business models for different portfolios, the new IFRS 9 could also facilitate FIs recognised at amortised cost in a portfolio held to collect contractual cash flows to engage in an infrequent trading activity (IFRS 9.B4.3). Some argue that this would be tailored to financial institutions that seek to avoid FV accounting for their positions which would result in arbitrariness (Gillard & Kathri, 2009). IFRS 9 also does not include financial liabilities which according to the IASB will follow in the near future (IASB, 2009h). Figure 4 illustrates the determination process of financial assets under new IFRS 9.

5. Conclusion

In the end, the question needs to be addressed whether the IASB has achieved in creating a new standard that is simpler and more practical for financial statements' users. As it was pointed out in the paper, the IASB has initiated an unprecedented open discussion about the future accounting principle for FIs.

The new standard has managed to allow for a simpler application as it has significantly reduced the number of rules. However, simplification comes at a cost for the users of financial statements. With the revised IAS 39, some areas such as embedded derivative accounting have been simplified considerably which has the effect that previously detailed regulation has been replaced by a very general standard. This leads to a loss of detailed and exception-friendly standards in favour of a general standard that is, however, easy to understand, apply and interpret. In this respect, the IASB has fulfilled its aim to reduce complexity in accounting. On the other hand, by limiting classification categories to only two options from previously four, an entity's business model and the contractual terms of the instrument with the business model having been given primacy, the IASB has also succeeded to achieve simplification in FI classification.

However, simplification has resulted in the loss of the category AfS which cause particular discontent with insurance companies and other investment firms. The focus on management intent has nevertheless shown weaknesses as this might be subject to arbitrariness again as management can declare different business models for different portfolios and reclassify by changing the model when market development does not favour recognition at FV. On the other hand, the retention of the FVO states clear focus on transparency to investors - another aim of the IASB. In sum, this has therefore also helped to achieve the IASB's intent.


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List of Appendices

Appendix 1: Statutory Declaration....................................................................................................19

Name:                   Bromig                   First Name:              Simon

Statutory Declaration:

I swear that I have written this paper on my own and with no other help than the literature and other supportive material listed in the appendix. Citations of sentences and parts of sentences are declared as such, while other imitations are clearly marked and linked to original sources with regards to extent and intention of the statements made. This thesis has never been handed in to any examination authority before and it is also not yet published.

Place, Date:              Vallendar, 26 November 2009


Simon Bromig - IAS 39: Classification and Measurement              16

[1] All currently within the scope of IAS 39.

[2]E.g. Asset backed securities (ABS) or a collateralised debt obligation (CDO).

[3]However, the former application area of IAS 39 did not concern FIs that were related to own equity instruments within the scope of IAS 32, particularly regarding option and subscription rights (IAS 39.2). Furthermore, IAS 39 was not applied for certain credit approvals and reimbursement claims referring to accruals within the scope of IAS 37.

[4] Categories served as description of valuation categories and did explicitly not qualify for disclosure.

[5] Liability recognition at fair value shall be discussed in the paragraph covering subsequent measurement.

[6] For more details refer to IAS 39.AG55-.AG56.

[7] Such as DCF-method or option pricing models (see IAS 39.48 and .AG69-.AG82).

[8] I.e. the settled time value of the given or received compensation (IAS 39.AG64).

[9] Financial assets qualifying as loans or receivables were not allowed to be designated to this category.

[10] However, this rule did not apply for a disposal which was as near maturity or settlement date so that no fundamental effect on the asset's fair value could arise. In addition, the tainting rule did also not apply to financial assets whose collected payments up to disposal generally met the overall redemption amount or if the disposal resulted from events which the entity was unable to affect (IAS 39.9).

[11] A listing on any active market is given when a regular price fixing takes place (IAS 39.AG71).

[12] given compliance with respective preconditions for this category (IAS 39.67-70).

[13] Instruments could also be classified under FVO if managed and their performance measured on FV basis.

[14] This was for instance the case for embedded termination rights on debt contracts.

[15] This is generally referred to as residual measurement.

[16] Exception: (1) equity instruments with no clearly ascertained fair value, (2) interest effects and amortisations of transaction cost of debt instruments (amortised cost), (3) claims on dividends, and (4) impairments needed be recognised through profit or loss.

[17] Hereby, the attached fair value at the moment of reclassification represented the amortised cost.

[18] An expiration of the retention period within the scope of IAS 39.9 requires two precedent business years.

[19] Particularly the European Commission which threatened to suspend application of IAS 39.

[20] Such as Asset Backed Securities, Collateralised Debt Obligetions, Credit Default Swaps.

[21] E.g. when fair value determination cost are greater than gains.

[22] Because structured liabilites without basic loan features must be recognised at FV through profit or loss.

[23] I.e. depend on the company's own credit spread.

[24] Seperation of embedded derivatives and financial host contracts for liabilities remains within IAS 39.

[25] Investors may not be able to assess FIs' genuine effect on profit or loss.

[26]Irrespective of the decision to exclude financial liabilities from the scope of IFRS 9.

[27]However, the IASB expects this to be very infrequent (IASB, 2009d).

[28] An amount recognised in OCI can never be reclassified through profit or loss at any later stage.

[29]In accordance with IAS 18 Revenue, unless such dividends clearly depict a cost recovery of the investment.

[30]In IAS 39 there used to be an exception allowing such instruements to be valued at cost.

[31] As insurance companies act as big investors on financial markets.

[32] Due to very restrictive regulation for held-to-maturity investments as outlined in The former IAS 39.

[33] Cf. IAS 39.67-70 and IAS 39.AG16 et seq.

[34] As short-term volatility does not interest the company, it holds the asset in view of its maturity.

[35] Depending on definition of business model, cf. (EFRAG, 2009a).

[36] I.e. this is the case for a  equity investments, cf. (GASB, 2009a).

[37] A financial asset is first assessed on business model and only then evaluated on contract-by-contract basis

[38] I.e. all former inconsistent requirements on matters of impairment reversal under IAS 39 are abolished.

[39] These instruments require a "look-through" approach that assesses all underlying assets (ABS, CDO, CDS).

[40] I.e. representing principal and interest on principal even if purchased at credit-loss-incurring discount.

[41] The ED previously suggested a representation in OCI.

[42] Source: cf. (IASB, 2009i)